An Open Letter to the Fed

Mr. Benjamin S. Bernanke
Chairman, Board of Governors of the Federal Reserve System
Mariner S. Eccles Building
20th Street and Constitution Avenue, N.W
Washington, DC 20551

Dear Mr. Bernanke:

I guess I was wrong about you. I’ve repeatedly written that you and the other members of the Federal Open Market Committee would not have the gumption to raise interest rates in 2010. Yesterday’s move by the FOMC to hike the discount rate by 25 basis points to a lofty 0.75% put the lie to my claims, and I, like Tiger Woods this morning, feel I must make a public apology. I’m sorry.

With this mea culpa come a few questions, though. If the spines around the FOMC conference table are indeed stiffening, why did you choose to raise only a largely symbolic rate, and then by only a token amount? Is it because, as Bank of America Merrill Lynch economist, Michael Hanson, suggests in the document attached herewith, that yesterday’s move was indeed not the FOMC’s idea? As Mr. Hanson states, “Also keep in mind that the Board of Governors cannot initiate an increase in the discount rate. Rather, a request must be made by one or more regional Fed banks. The press release indicated that the Board approved requests from ‘the boards of directors of the 12 Federal Reserve Banks’ — presumably it wanted to wait for all 12 banks to make such a request before acting.” If Mr. Hanson’s presumption is true, isn’t yesterday’s move to boost the discount rate more a reflection of responsible policy attitudes by the district banks rather than of the Board itself?

Furthermore, Mr. Bernanke, why did the Board go to such great pains to make it clear to the world that yesterday’s move did not signal a policy change? Perhaps tellingly, the following paragraph from the release itself comes before any mention of a change in the discount rate:

“Like the closure of a number of extraordinary credit programs earlier this month, these changes are intended as a further normalization of the Federal Reserve’s lending facilities. The modifications are not expected to lead to tighter financial conditions for households and businesses and do not signal any change in the outlook for the economy or for monetary policy, which remains about as it was at the January meeting of the Federal Open Market Committee (FOMC). At that meeting, the Committee left its target range for the federal funds rate at 0 to 1/4 percent and said it anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.” (source: Federal Reserve press release)

Forgive me, Mr. Bernanke, but I’m confused by both this paragraph and its placement in the release. Why did the Board reaffirm its commitment to a near zero funds rate for an “extended period” before announcing the actual change in the discount rate? In journalism, this tactic is called “burying the lead”; in politics, it is cynically called C.Y.A.; and, with apologies to Mary Poppins, in finance it is called “a spoonful of sugar that helps the medicine go down”. Is the FOMC really so afraid of either Congress or the asset markets that it felt the need to remind the world about ZIRP prior to revealing the nudge higher in the discount rate? Since stocks, the dollar, commodities, and even the 30 Treasury bond are all higher as I write these words (1pm est), Mr. Market certainly approves of this form of “tightening”.

But I’m not alone, sir, in wondering whether yesterday’s action by the Fed is a genuine tightening, a trial balloon-style hint of interest rate hikes to come, or, as Mr. Hanson puts it, “much ado about nothing”. Perhaps a little more of the transparency you claim to covet is in order, Mr. Bernanke. You should know that the following riddle has been offered up near at least one water cooler today: “When is an interest rate hike not a tightening? When it’s announced by the Bernanke Fed.” Or, were a blizzard of questions and a trail of confusion the goal of yesterday’s action all along?

Sincere in My Desire to Withhold Further Judgment Until I Hear From You,

Jack McHugh