The Dog Ate My Exit Strategy

On July 21, 2009, in the Wall Street Journal, Fed Chairman Ben Bernanke outlined the smooth and seamless exit strategy for the Federal Reserve and its now overly accommodative policies. In 2009 the Dow Jones Industrial Average was trading at 8,100... it's now at 14,500.

Loose accommodative money has increased stock values and had little impact on real unemployment. One might think the Fed should reevaluate their theories and assumptions. In the meantime, full speed ahead.

The aggregate effect on employment by this loose money policy, as measured by a percentage of workforce, is muted at best. Ben has his hammer, and he is certain that unemployment is the nail. Can monetary policy improve employment? Or does it merely inflate financial asset prices? Perhaps the world has changed.

Bernanke's exit strategy points in the article of July 2009 today seem removed from reality. He then presented a formidable plan grounded in historical Federal Reserve activities. But at his recent press conference, he suggested he may not be around to conduct the "exit". Darn it. He was quick to assure all in the room that there are many economists who could execute an "exit" plan. He failed to mention any names.

May I offer a few? David Blaine, Harry Blackstone, Kreskin, or David Copperfield. Perhaps they can pull off these monetary magics if Ben himself does the exiting. If these men can bend a spoon just by looking at it, perhaps going from a net buyer of Treasuries and agency paper and the primary supporter of Treasury debt prices, to a net seller without causing panic and a vicious market downswing is also within their powers. Voila.

We are confident we have the necessary tools to withdraw policy accommodation, when that becomes appropriate, in a smooth and timely manner.

First, the Federal Reserve could drain bank reserves and reduce the excess liquidity at other institutions by arranging large-scale reverse repurchase agreements with financial market participants, including banks, government-sponsored enterprises and other institutions. Reverse repurchase agreements involve the sale by the Fed of securities from its portfolio with an agreement to buy the securities back at a slightly higher price at a later date.

Presto. Except one thing. The Fed is currently a purchaser of Treasury securities. It is doing so because others will not. Going from a buyer at prices others won't pay to being a seller is quite a distance to travel. First the Fed must stop buying Treasuries. Then there must be some type of return to a free-market environment. Then the Fed must become the sellers of Treasuries the exit strategy step suggests. Anyone want to be first on a 2 Trillion dollar sell order? (2 Trillion being the recent expansion in the balance sheet.)

Second, the Treasury could sell bills and deposit the proceeds with the Federal Reserve. When purchasers pay for the securities, the Treasury's account at the Federal Reserve rises and reserve balances decline.

Whoa. The best buyer of Treasury bills now is the Federal Reserve. So, as the strategy suggests, the Fed buys the bills (a cost to the Fed) and then deposits those bills into the Treasury's account, as the strategy suggests. The Fed's account will go down, and the Treasury's balances go up. The Fed's balance sheet will rise, and the Treasury's debt obligations will rise also. And the Treasury will have a credit balance at the Fed while the government is running a massive deficit? To make the strategy work, the Treasury must find other buyers of the Treasury bills than the Federal Reserve. That's the tricky part.

Although the Treasury's operations are helpful, to protect the independence of monetary policy, we must take care to ensure that we can achieve our policy objectives without reliance on the Treasury.

The Treasury is now reliant on the Federal Reserve. The Federal Reserve's Quantitative Easing programs assist the Treasury in its borrowing.

Third, using the authority Congress gave us to pay interest on banks' balances at the Fed, we can offer term deposits to banks -- analogous to the certificates of deposit that banks offer their customers. Bank funds held in term deposits at the Fed would not be available for the federal funds market.

Fourth, if necessary, the Fed could reduce reserves by selling a portion of its holdings of long-term securities into the open market.

Sure it could. Again, the Fed must move from being the best buyer in the market to being a net seller of securities. That is quite a journey.

The article is declarative on some levels, subliminally suggestive in others.

The declarative part is that Ben Bernanke knows how to get us out of this. In all fairness, the article was written in 2009. But, in all fairness, where is the "new" exit strategy? Is there one?

What is subliminally suggested is that the Fed will eventually reduce its balance sheet by selling off securities or allowing securities to mature. Also suggested is that Ben will be in command. Both now seem unlikely.

The Fed must halt its purchases each month of billions of dollars of securities before it can even begin to consider selling off its portfolio, thus reducing its balance sheet.

But step one will never quite happen, for two reasons:

First, Bernanke recently said that the Fed will restart monthly purchases whenever it deems necessary. In other words the "emergency program" will never be over. It may pause, but not terminate.

So the Fed has become something it once was not. It is an open-ended flow of money, monitored by no one outside the Fed and self-empowered to tweak markets and manage the economy. That is a leap from the "maximizing employment, stable prices, and moderate interest rate" mandates. (Yes, there are three mandates.)

Secondly, the Federal government dedicates approximately 6% of its budget to service debt (make interest payments). Currently with the lowest interest rates in history, any uptick in rates would blow apart the already strained Federal budget.

There isn't much reality for the 2009 "exit strategy" from the Fed. Moving from "neutral" to a seller of securities to manage monetary affairs is one thing. To move from being the best buyer of securities to a seller is a leap in realistic expectation. Bernanke's 2009 exit plan is not grounded in current reality, and his quiet saunter towards his own tenure-ending exit is telling. The Fed has gone from 'toe in the water" activities to being "hip deep" in economic management. Can it ever extricate itself? Does it want to?

It is fair to ask "Is there a viable Federal Reserve exit strategy considering all the QE programs from 2009 to today"? Dare we ask?

On July 21, 2009, in the Wall Street Journal, Fed Chairman Ben Bernanke outlined the smooth and seamless exit strategy for the Federal Reserve and its now overly accommodative policies.

In 2009 the Dow Jones Industrial Average was trading at 8,100... it's now at 14,500.

Loose accommodative money has increased stock values and had little impact on real unemployment. One might think the Fed should reevaluate their theories and assumptions. In the meantime, full speed ahead.

The aggregate effect on employment by this loose money policy, as measured by a percentage of workforce, is muted at best. Ben has his hammer, and he is certain that unemployment is the nail. Can monetary policy improve employment? Or does it merely inflate financial asset prices? Perhaps the world has changed.

Bernanke's exit strategy points in the article of July 2009 today seem removed from reality. He then presented a formidable plan grounded in historical Federal Reserve activities. But at his recent press conference, he suggested he may not be around to conduct the "exit". Darn it. He was quick to assure all in the room that there are many economists who could execute an "exit" plan. He failed to mention any names.

May I offer a few? David Blaine, Harry Blackstone, Kreskin, or David Copperfield. Perhaps they can pull off these monetary magics if Ben himself does the exiting. If these men can bend a spoon just by looking at it, perhaps going from a net buyer of Treasuries and agency paper and the primary supporter of Treasury debt prices, to a net seller without causing panic and a vicious market downswing is also within their powers. Voila.

We are confident we have the necessary tools to withdraw policy accommodation, when that becomes appropriate, in a smooth and timely manner.

First, the Federal Reserve could drain bank reserves and reduce the excess liquidity at other institutions by arranging large-scale reverse repurchase agreements with financial market participants, including banks, government-sponsored enterprises and other institutions. Reverse repurchase agreements involve the sale by the Fed of securities from its portfolio with an agreement to buy the securities back at a slightly higher price at a later date.

Presto. Except one thing. The Fed is currently a purchaser of Treasury securities. It is doing so because others will not. Going from a buyer at prices others won't pay to being a seller is quite a distance to travel. First the Fed must stop buying Treasuries. Then there must be some type of return to a free-market environment. Then the Fed must become the sellers of Treasuries the exit strategy step suggests. Anyone want to be first on a 2 Trillion dollar sell order? (2 Trillion being the recent expansion in the balance sheet.)

Second, the Treasury could sell bills and deposit the proceeds with the Federal Reserve. When purchasers pay for the securities, the Treasury's account at the Federal Reserve rises and reserve balances decline.

Whoa. The best buyer of Treasury bills now is the Federal Reserve. So, as the strategy suggests, the Fed buys the bills (a cost to the Fed) and then deposits those bills into the Treasury's account, as the strategy suggests. The Fed's account will go down, and the Treasury's balances go up. The Fed's balance sheet will rise, and the Treasury's debt obligations will rise also. And the Treasury will have a credit balance at the Fed while the government is running a massive deficit? To make the strategy work, the Treasury must find other buyers of the Treasury bills than the Federal Reserve. That's the tricky part.

Although the Treasury's operations are helpful, to protect the independence of monetary policy, we must take care to ensure that we can achieve our policy objectives without reliance on the Treasury.

The Treasury is now reliant on the Federal Reserve. The Federal Reserve's Quantitative Easing programs assist the Treasury in its borrowing.

Third, using the authority Congress gave us to pay interest on banks' balances at the Fed, we can offer term deposits to banks -- analogous to the certificates of deposit that banks offer their customers. Bank funds held in term deposits at the Fed would not be available for the federal funds market.

Fourth, if necessary, the Fed could reduce reserves by selling a portion of its holdings of long-term securities into the open market.

Sure it could. Again, the Fed must move from being the best buyer in the market to being a net seller of securities. That is quite a journey.

The article is declarative on some levels, subliminally suggestive in others.

The declarative part is that Ben Bernanke knows how to get us out of this. In all fairness, the article was written in 2009. But, in all fairness, where is the "new" exit strategy? Is there one?

What is subliminally suggested is that the Fed will eventually reduce its balance sheet by selling off securities or allowing securities to mature. Also suggested is that Ben will be in command. Both now seem unlikely.

The Fed must halt its purchases each month of billions of dollars of securities before it can even begin to consider selling off its portfolio, thus reducing its balance sheet.

But step one will never quite happen, for two reasons:

First, Bernanke recently said that the Fed will restart monthly purchases whenever it deems necessary. In other words the "emergency program" will never be over. It may pause, but not terminate.

So the Fed has become something it once was not. It is an open-ended flow of money, monitored by no one outside the Fed and self-empowered to tweak markets and manage the economy. That is a leap from the "maximizing employment, stable prices, and moderate interest rate" mandates. (Yes, there are three mandates.)

Secondly, the Federal government dedicates approximately 6% of its budget to service debt (make interest payments). Currently with the lowest interest rates in history, any uptick in rates would blow apart the already strained Federal budget.

There isn't much reality for the 2009 "exit strategy" from the Fed. Moving from "neutral" to a seller of securities to manage monetary affairs is one thing. To move from being the best buyer of securities to a seller is a leap in realistic expectation. Bernanke's 2009 exit plan is not grounded in current reality, and his quiet saunter towards his own tenure-ending exit is telling. The Fed has gone from 'toe in the water" activities to being "hip deep" in economic management. Can it ever extricate itself? Does it want to?

It is fair to ask "Is there a viable Federal Reserve exit strategy considering all the QE programs from 2009 to today"? Dare we ask?