Flash Point: What We Missed the First Time Around

In The Hole in Jackson Hole we analyzed Bernanke’s Jackson Hole speech. We wish to revisit our key point #6 and this phrase of Bernake’s (marked as 3 parts):

[1] If we are willing to take as a working assumption that the effects of easier financial conditions on the economy are similar to those observed historically, [2] then econometric models can be used to estimate the effects of LSAPs on the economy. [3] Model simulations conducted at the Federal Reserve generally find that the securities purchase programs have provided significant help for the economy.

When we wrote the initial post, our attention had been arrested by the part of Bernanke’s speech marked [1]. That is, his assumption that in the current economic environment, Fed tools (stimulus) are operating as they have historically. As we noted:

 The fallacies in this assumption are the admission that with ZIRP, using tools they have no experience with, and failing to understand that this is a balance sheet as well as a business cycle recession means they have no historical referent to compare to! Their models cannot possibly work.

The implication of our assertion is that as per the part marked [2] above, Fed models cannot be used to estimate the effects of LSAPs on the economy.

What we missed was the importance of the part of his speech marked [3]. This part states that the Fed models show that LSAP programs have had a positive effect on the economy. This positive interpretation feeds back into the first part noted and is used to corroborate the validity of the Fed models (part [2]). In other words, there modes show that LSAPs have a positive effect and because they show a positive effect, the models are valid.

This circular reasoning is another argument for the fallaciousness of the Fed’s assumptions and their blindness to the ineffectiveness of their policies.

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