TAPERING is not tightening, slowing is not reversing, and adding artificial sweetener to your coffee is not the same as a dollop of sugar.
This carefully crafted message from the US Federal Reserve last week was designed to stop markets getting ahead of themselves after the first hint of tapering roiled global stock indices, bond markets, commodities and currencies. But are investors right to be worried? Will even the early stages of withdrawal from ultra-easy policy constitute monetary tightening in this environment, rather than a shuffle back to a neutral stance?
This concept was raised in a remark by Gene Ludwig, an American expert on banking regulation, risk management and fiscal policy. Ludwig was US comptroller of the currency under President Bill Clinton, supervising the weight of US banking assets. One of his roles was to alleviate the credit crunch in the early 1990s.
Ludwig thinks it wise to be mindful of the excesses of the past, and the bubbles liquidity can create. But his point pertains more to the issue of how delicate the process of extraction could be.
Blunt instruments such as quantitative easing (QE) and interest rates have, to an extent, been successful in firing up asset classes and adding to economic growth (although no-one can say by how much exactly). This inexact science poses a problem on retreat. Will turning the screws and reducing QE to a trickle do more damage than anyone thinks?
How much escape velocity will exist in the US economy after QE when banks face higher borrowing costs and tighter regulation? This is not to mention the fiscal drag from budget cuts that had economists so concerned at the start of the year.
We disposed of economic textbooks when the great QE experiment began. We are now doggedly re-reading them for guidance as we begin to withdraw monetary stimulus.
Perhaps monetary policy is simply no longer as flexible. After all, the neutral rate is the policy setting at which inflation remains stable and the economy is balanced. These metrics haven’t been achieved, so is tapering premature? Run-of-the-mill monetary policy stopped being effective after the financial crisis. Removing QE suggests that the “vanilla” approach to monetary policy has regained its power.
But it seems even Ben Bernanke doubts that is the case. Why else would he want to keep the option to increase asset purchases again if required?
There are other clues as to whether unwinding stimulus could threaten price stability. James Bullard, president of St Louis Federal Reserve, has been scathing about the timing of taper talk when inflation remains worryingly low. A 2 per cent inflation target could be further from the Fed’s reach if QE taps swivel. If inflation falls and growth slows, then tapering will be tightening despite protests to the contrary.
Karen Tso is an anchor for Squawk Box Europe on CNBC. @cnbckaren