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What to Expect From Jackson Hole: 'Party On'

NEW YORK (TheStreet) -- In the past, the Federal Reserve's Jackson Hole Symposium produced some new and controversial proposals. Two years ago, for example, then-Fed Chairman Ben Bernanke introduced QE3--and the financial markets loved it. So what can we expect from this year's symposium?

Given the stances that Janet Yellen has taken throughout her short tenure as chairwoman, it would be very surprising if she didn't use Friday's speech to justify continued zero interest rate policies (ZIRP) and insist that the Fed's monetary policy tools aren't for market stabilization (i.e., "macroprudential" policies are for that). Let's look at the evidence.


At the end of June, the Bank for International Settlements (BIS), the central bank for central bankers, put out a report saying that the world's leading central banks should not fall into the trap of raising rates "too slowly and too late," adding that "the risk of normalizing [interest rates] too late and too gradually should not be underestimated."

The Deal's Paula Schaap spoke with economist David Levy on what he thinks we're likely to hear from Fed Chair Janet Yellen:

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The BIS said governments should promote policies that boost their economies, like removing obstacles and rules regarding hiring and firing (e.g., Southern Europe) like Germany did some 20 years ago, structurally reform their tax codes (e.g., U.S.), strengthen the capital base of their banking system (e.g., Europe), and encourage capital formation.

Fed's Answer: "No Way"

A couple of days later, the BIS got its answer from the Fed, as Yellen distanced herself from all of these ideas. In a somewhat shocking statement, she said that the Fed's monetary policy tools--which include short-term rate setting and its balance sheet--were not intended to anticipate the risk of financial instability. Instead, the Fed could use its regulatory tools--rules on bank capital, derivatives and margins--to ensure the overall health of the financial system, a policy called "macroprudential." Later, in her semi-annual Humphrey-Hawkins testimony to Congress, she clarified the meaning of the term: regulators of the financial system are responsible for financial stability.

Macroprudential Policy

There are two critical issues here: 1) the Fed's monetary policy of financial repression (ZIRP) is actually causing financial risk because investors are stretching for yield in the junk bond market, which Yellen acknowledged to Congress appeared stretched, and 2) the Fed is still the primary regulator of financial institutions in the nation and is supposed to be the "lender of last resort," a function that is aimed at keeping markets and the economy "financially stable." So, we would expect that the Fed would use every tool in its toolkit--including monetary policy--to also fulfill its regulatory obligations.

Track Record on Bubbles

Since the Fed wants to rely on its regulatory--not monetary--powers to insure financial stability, let's look at the regulatory track record on bubbles. In early 2007, Bernanke, assured the public that the "the problems in the subprime market seem likely to be contained." At the time of those remarks, that bubble was already bursting and the primary regulator didn't see the devastating implications. Then, as it burst, it took the biggest dose of liquidity (via the Fed's balance sheet) the world had ever seen to keep the financial system from collapse.

Let's also recognize that the regulatory process is reactionary. Every single piece of major financial legislation--most recently Sarbanes-Oxley and Dodd-Frank--has been the result of some financial disaster, not in anticipation of it. The regulators simply aren't capable of stopping financial instability, either because they don't recognize it, or because they do not yet have the regulatory powers from Congress to prevent it.

So, Party-On

My expectation from Jackson Hole is that the Fed will confirm a continuation of ZIRP despite the misallocation of resources or the bubbles it causes. To justify a continuation of ZIRP, Yellen needs to reiterate her stance on "macroprudential" policy--that it is the function of the regulatory arm of the Fed and other agencies to prevent bubbles.

No one in the financial arena, including myself, actually believes that the Fed won't provide liquidity and do what it can with its balance sheet in the event of another financial implosion. I suspect the current Fed stance is there only as a continued justification of current policies, which are being questioned by more and more economists.

So, after Jackson Hole, the party in the financial markets is likely to continue awhile longer.

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