As published for The Roosevelt Room:
Central bankers gathered in Jackson Hole, Wyoming last week to review and assess their performance during the financial crisis and economic downturn, and to compare notes on the way forward as the global financial system stabilizes and nascent growth takes root.
They had a lot to review. Central banks — most notably, Ben Bernanke’s Federal Reserve — took extraordinary measures over the past year to walk the financial system back from the brink of collapse and to juice growth as the global economy submerged into a deep recession. As challenging as those actions were, the way forward may be trickier.
It wasn’t necessary for the Fed to act with precision in the midst of a crisis — there was little precise about plunging the policy rate to near-zero. And not much scientific about creating asset liquidity programs measured in the trillions of dollars. — pick a big enough “shock and awe” number and hope it does the trick.
But the way forward will require far more precision to avoid derailing a fragile and bumpy recovery, balancing economic growth and price stability, all while weaning the financial system off of novel credit liquidity programs.
While I have enormous confidence in Chairman Bernanke and the Federal Reserve staff to chart the way forward, the most likely outcome is that the Fed will make a mistake. This isn’t criticism, just an acknowledgment that the Fed and other major central banks have an enormously complicated task ahead of them, involving many judgment calls, and it’s crazy to think they’ll get all of them right.
Central banks don’t run on auto pilot or rigid computer models. Data helps, but decisions are made by human beings and human beings tend to make mistakes when they do something for the first time — and no doubt, the Fed’s decision matrix is unprecedented. Over the next 18 months the Fed must execute the withdrawal of complex credit liquidity programs and fine tune monetary policy in an uncertain and dynamic environment with imperfect information about nature of the recovery and the performance of financial institutions.
Given the precarious state of household balance sheets and the continued uncertain outlook for the financial sector, an economic recovery with dips back to negative growth is already likely over the next two years. If the Fed gets wrong the sequencing, magnitude, or coordination (in the U.S., and across borders) of policy – or sends the wrong signals about its intentions — even that likely expectation would prove optimistic.
Even if we assign the Fed a 90% likelihood of hitting the bullseye with any one of its many decisions, and ignore the possibility of unexpected events, it becomes highly probably that the Fed will make a mistake.
Which decision will be the “big” mistake? Which one is most likely? Assess your risk and make your own judgment – after all, that’s the fun of being in a market, right?
But don’t expect policy perfection. Mistakes will happen.