The economy was “catastrophically bad” in the first quarter of 2014, says Alan Blinder, and the Princeton economics professor is less sanguine than many other economists about economic growth for the rest of the year.
Despite the fact that unemployment has not settled between 5.2% and 6%, and that inflation, as measured by core personal consumption expenditures, remains below the Federal reserve’s “macro mission” target of 2%, the former Fed vice chairman nevertheless expects the Fed to continue tapering its buying of Treasuries and mortgage-backed securities through October or December of this year.
Tapering, however, does not mean that the Fed’s balance sheet will shrink to anywhere near $900 billion, where it stood “prior to the Lehman collapse.” Blinder says his “guess” is that it will settle around the $1.5 trillion to $2 trillion mark.
Then what will the Fed do? When will the Fed-controlled federal funds rate be raised from its near-zero level, where it has been since 2008? How is the Fed, or more specifically the Federal Open Market Committee, making its decisions? The answers to those questions were at the core of Blinder’s keynote speech Sunday evening at the Investment Management Consultants Association’s national conference in Boston, and he claritied and elaborated on those answers in an individual interview after the speech.
First, about those bad first-quarter economic numbers. Blinder said in the interview that he believes the 0.1% annualized GDP growth reported by the Commerce Department on April 30 may well be revised, as some observers have speculated. However, he believes it may be revised downward, not upward, and may even be negative by the next revision, which Commerce’s Bureau of Economic Analysis plans to release on May 29.
There is one tangible benefit to the economy this year, he said. The government’s “Titanically large drag on the economy” last year will be smaller in 2014, though he quipped that “the bar wasn’t too high” in predicting that the government’s heavy hand will be lighter this year.
Blinder says he remains concerned about the state of housing in the U.S., and the lack of a “wealth effect” that would encourage more consumer spending. Looking at the other large economies around the world, he called the Japanese economy “surprisingly good.” Though with a new consumption tax that was implemented just last month by Prime Minister Shinzo Abe, Blinder is concerned that the Japanese economy might be staggered like it was the last time an increase in the consumption tax occurred back in 1997, which pushed Japan into recession.
As for China, Blinder believes that if that nation’s growth only “slows” down to 7.5%, “we won’t even notice it,” partly because “they don’t buy much from us.” By contrast, he called Europe “decidedly a mixed bag,” but said it certainly “won’t give the U.S. a boost.”
There is always the possibility of an oil shock, he said, which might be prompted by the Russia-Ukraine conflict, though he stressed the rather minimal economic footprint of Ukraine, if not the political. What’s Next for the Fed?
Assuming that QE ends in October or December of this year, when will the federal funds rate lift off? Blinder believes that may occur a good six to 12 months after tapering ends. In the interview, Blinder said he expected a slow, steady rise in the fed funds rate that will eventually be reflected in higher longer-term interest rates, again at a slow pace — assuming that Chairwoman Janet Yellen can corral the FOMC members to cooperate.
Blinder has been teaching economics at Princeton for a long time, interrupted by service in Washington on Bill Clinton’s Council of Economic Advisers and as vice chairman of the Federal Reserve. An admitted friend of the former chairman Ben Bernanke and of Yellen, Blinder is on record as having supported Yellen to replace Bernanke last year, and has long advocated, like Bernanke and Yellen, for the Fed to take a more “open, transparent” approach to the outside world.
Bernanke and now Yellen also have taken a different approach to decision making, he said. The traditional power structure at the Fed, most famously epitomized by former chairs Paul Volcker and Alan Greenspan, was that of a “dominant chairman,” to the point that the media would report on “what will Volcker or Greenspan do, not ‘What will the Fed do?’” in its reporting.
Bernanke wanted to move away from that “more personal” structure, Blinder said, and believed that better decision making could be encouraged through a committee approach, which reflected Bernanke’s own personal style. Yellen also believes in the power of a committee-based decision, but Blinder believes she’ll try to “exert more authority” on the FOMC’s deliberations, in a “nuanced way.”
However, Blinder suggested in his speech that Yellen may be facing a “cacophony” problem, with various members of the FOMC speaking out publicly and often as not disagreeing with one another. “As taper comes to a close” in his predicted October or December timeframe, Blinder expects “a major, vocal debate” at the FOMC over “what comes next” for the Fed.
That debate between the Fed’s ‘hawks and doves’ may well “rattle the markets,” he worries. “Traders will completely” focus on the taper and what will come afterward, he said, “if they haven’t already.”
In the interview, Blinder said the problem isn’t that there’s disagreement among the FOMC members over what actions to take or not take. Rather, it’s that there’s public disagreement after a consensus has been reached that could cause those market jitters. Yellen, he said, “has her work cut out for her.”
What about the financial crisis and the regulations it spawned, in particular the Dodd-Frank Act? In his speech, Blinder said that there was “such a severe backlash” worldwide over “the bailout” of financial firms, in the event of another similar crisis, he worries that there won’t be the political will to take similar bold action. As for Dodd-Frank, while it’s far from perfect, he said he “likes Dodd-Frank in general” and argued that, generally speaking, the rest of the world is behind the U.S. in financial reform. In the interview, when asked about the perceived overregulation of the industry via Dodd-Frank, he said that “the regulated never like to have regulation.” Blinder said that imposing a fiduciary duty on advice givers would be good for investors, though he said it was important that the different sides of the debate be heard.
With that in mind, he took a different approach to the controversy over Dodd-Frank’s complexity and scope. After most similar wide-ranging legislation, he said in the interview, Congress usually “corrects” the original act through additional legislation that addresses its shortcomings. But with the partisan atmosphere in Washington, where the Republicans have tried and failed to repeal Dodd Frank “42 times,” such corrective legislation has no chance to be approved.
In the question and answer session following his prepared remarks, he agreed that “there’s too much cash” in the banks, and said he had long lobbied (unsuccessfully) to remove the 25 basis points of interest that the Fed is paying to banks on their excess cash.
Check out ThinkAdvisor’s special section on IMCA’s 2014 Conference for full coverage.