Chairman Powell arrests market decline – highlights policy credibility problem

The below screenshot is from this CNBC article:

Given my last post heaping criticism on the Fed for doing nothing when something is likely required, after seeing this news I thought I had in some small way been granted a wish.

But after pondering the situation in greater depth, it seems more to me like there’s a credibility problem somewhere in the current monetary regime. Obviously, the credibility problem hasn’t anything to do with Powell as his one or two-sentence assurance that the Fed is on top of things was all that was required to ease policy even if temporarily. But how absurd is it for markets to respond to such a small gesture by one guy, as if the previous bearish sentiment had something to do with assumptions about whether the Fed would react too slowly or perhaps do nothing at all as policy naturally tightens on itself. It might be that because the Fed had not accommodated additional demand for money thus far, it would be natural to assume that it wouldn’t in the immediate future, and of course, this is how supply shocks are translated into demand shocks, as in MV=PY.

Suppose that the Fed has its plan for M all mapped out through the end of the year which is going along on course. But something happens out in the real world, like the Trump bull in the trade China shop, and people start cashing out to save it for the rainy day that is looking more and more like it will come sooner rather than later. This may not be technically correct, but I use V as the proxy here because what happens to the right must happen to the left, and unaccommodated excess demand for money is generally accompanied by declining V.

Even in the best case scenario of the Fed being slow to react means constant M, though we have some idea of what is and has been happening to M with asset sales in excess of those purchased in the presence of a stable IoER rate that was likely too high two months ago and thus even more inappropriate for today, declining V would still be a problem for P and Y (or together for NGDP).

We’ve already seen decline of the stuff on the right in MV=PY in the Atlanta Fed’s GDPNow cast that started well before the Trump bull was let loose to exacerbate the “tight” problem. And if anyone wants to know what happened to NGDP for 2019, I’d say that Trump kicked the Fed while it was down with credibility for almost nothing besides perennially tight money even as Rome burns – it might go away for a little while, but grows back bigger and stronger than before.

So, if I can take a look at what is happening around me with the insight of two pairs of letters separated by an equal sign, what the heck has been going on at the Fed all year? The market signals couldn’t be clearer that the Fed has been doing the wrong things all year and was expected to keep doing them while the Donald exacerbates the situation.

This is what needs to be fixed. The Fed needs level targeting like nothing ever before.