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Mr. Kasriel is the former Chief Economist of The Northern Trust Company and although he wore an academic hat (Kellogg) he's actually pretty good at this stuff.
From The Econtrarian:
Fed Tapering -- Shades of 1937?
In the press conference immediately following the December 17-18, 2013 FOMC meeting, Fed Chairman Bernanke indicated that it was the FOMC’s current plan to have terminated Federal Reserve outright securities purchases by the end of 2014, commencing with a $10 billion reduction in securities purchases immediately after the December 2013 FOMC meeting and then continuing to taper its purchases by about $10 billion after each 2014 FOMC meeting. Of course, this tapering plan is subject to modification in either direction depending on forthcoming economic and financial market developments.This tapering plan is much more aggressive than what I had anticipated. I had thought that the FOMC would pare its securities purchases back from $85 billion per month to $75 billion per month early in 2014, hold them there until mid 2014, and then pare them back to $65 billion per month for the remainder of 2014. My assumption was clearly wrong by an order of magnitude. If the Fed were to follow through with its announced tapering plan, then, all else the same, this would represent a significant tightening in U.S. monetary policy, with negative implications for the behavior of the U.S. economy and U.S. risk-asset prices starting sometime in the second half of 2014 and extending into 2015.Of course, all else is unlikely to be the same. From my perspective, the most important factor bearing on the restrictiveness of the Fed’s tapering plan will be the amount of credit created by commercial banks and other depository institutions. If banks should step up their credit creation to its 50-year median pace of 7-1/2%, then the Fed’s tapering will not have resulted in any meaningful tightening in monetary policy. Alternatively, if bank credit continues to grow in 2014 at its paltry 2013 December-over-December pace of 0.92%, then I would expect a sharp deceleration in the growth of nominal domestic spending to take hold sometime in the second half of 2014.The reason I mentioned 1937 in the title of this commentary is that in the aftermath of Fed restrictive policy actions commencing in the summer of 1936, the U.S. economy, which had been experiencing a vigorous recovery, slipped back into recession in mid 1937. On August 16, 1936, March 1, 1937 and May 1, 1937, the Federal Reserve raised the percentage of reserves banks were required to hold against deposits. The cumulative effect of this was to double the required-reserve ratio. The rationale on the part of the Fed for this doubling in the required-reserve ratio was to “soak up” what, at that time, was a massive amount of bank regulatory excess reserves. The Fed feared that banks would aggressively begin using these excess reserves to create credit, which, in turn, might result in a sharp acceleration in inflation. What the Fed did not understand was that these excess reserves held by banks were not “excess” in an economic sense. Because of the experience of bank runs in the early 1930s, banks desired to hold more idle cash reserves for liquidity purposes. As the Fed increased the required-reserve ratio, which converted hitherto regulatory excess reserves into required reserves, banks, trying to maintain their higher desired liquidity ratios, pared back their loans and securities. Bank credit, which had started growing again in 1934 after its severe contraction in the early 1930s, stalled out in the second half of 1936 and began to contract in the second half of 1937. The business expansion that had commenced in the spring of 1933 peaked out in May 1937.Now, I am not predicting that the current U.S. economic expansion will peak out later this year or early in 2015 because of Fed tapering. But what I am suggesting is that Fed monetary policy will become more restrictive in 2014 and that it would be prudent for investors to keep track of what bank credit is doing as the Fed cuts back on its credit creation. In the chart below, I have plotted four 2014 scenarios for the growth in combined Fed credit (Fed securities holdings obtained via outright purchases and repurchase agreements) and break-adjusted commercial bank credit along with actual growth in this credit aggregate from December 2008 through December 2013. The Fed-credit component in all of the scenarios is the same. Per Bernanke’s December news conference, the Fed is assumed to taper its outright securities purchases by $10 billion per FOMC meeting, which implies that it will have terminated it securities purchases by the end of 2014. Scenario 1 assumes that bank credit in 2014 will increase at an annual rate of 0.92%, the December-over-December increase in 2013. Scenario 2 assumes that bank credit in 2014 will increase at an annual rate of 3.66%, the annualized rate of increase in the three months ended December 2013. Scenario 3 assumes that bank credit in 2014 will increase at an annualized rate of 5.85%, the annualized rate of increase in December vs. November 2013. And Scenario 4 assumes that bank credit in 2014 will increase at an annualized rate of 7.50%, the median month vs. year-ago month percent change from January 1960 through December 2013......At the end of December 2013, the sum of Fed and bank credit was up 9.4% vs. December 2012. The projected December 2014 vs. December 2013 changes in the sum of Fed and bank credit are 3.8% for Scenario 1, 5.8% for Scenario 2, 7.4% for Scenario 3, and 8.6% for Scenario 4....MORE
