2014-05-16

Dissecting Mr Stein's Contributions: Why He Is Wrong and Why Forward Guidance Can Work

This is a longer article examining a recent speech by FOMC member Jeremy Stein. With US stock markets hitting fresh all-time highs this week, it is perhaps a good opportunity to reflect on why some of the criticism of the Fed’s highly supportive monetary policy has been misplaced. As suggested in Monday’s commentary and on previous occasions, there are very good reasons to believe the S&P 500 can trade up to new highs. The longer-term target of 2,200 – 2,300 is achievable given the strong underlying trend in profits, the sharp rise in productive investment, the downward pressure on inflation rates (particularly from China) and the continuing recovery in US house prices.  However, for equity markets to sustain the recent advances, monetary policy will need to remain accommodating. That will be possible if the authorities can successfully show that its attempts to prevent a rise in leverage across the real economy are succeeding. We will have more to say on that in subsequent GFC articles.
For today, the focus is on Mr Stein’s latest speech (“Challenges for Monetary Policy Communication”, 6 May 2014). Mr Stein may be leaving the FOMC at the end of this month, but it is important to dissect his views to understand why there are so many misconceptions around non-conventional monetary policy. Mr Stein questions the efficacy of forward rate guidance. This is misplaced.  If the Fed is successful in its application of macro-prudential tools, effective communication can deliver an enduring economic recovery, one accompanied by higher equity values.