Sunday, August 29, 2010

Bernanke Lays Out Policy Options for US Economy

Ben Bernanke, Chairman of the Fed outlined his policy options to help the US economy in a speech on Friday. The stock market loved it as the DJIA closed up 165 points after starting off with some pretty sluggish prices earllier in the day. Allow me to go over these rather quickly:

1. Quantatitive easing - silly me I did not realize this was a choice. If Uncle Same can't sell its debt someone has to buy it.

2. Promising to keep rates low - you have to be kidding me. Promises are just that, promises. Maybe they will and maybe they won't.

3. Paying 0% interest of bank excess reserves at the Fed - we are basically there now.

4. Targeting higher interest rates - silly me I did not realize this was a choice. I assumed it was inevitable.

Don't get me wrong I think Ben Bernanke is doing the best he can. Besides I would rather have an expert on the Great Depression as Fed Chairman then a lot of people. But, the list tells me just how short of ammo the Fed really is. Text in bold is my emphasis. From The BBC:

Federal Reserve chairman Ben Bernanke has laid out four "unconventional" policy options to boost the US economy.

Top of the list is more "quantitative easing" - mass purchases of debt.

Speaking to fellow central bankers at the annual Jackson Hole symposium in Wyoming he said the recovery had slowed to "a pace somewhat weaker" than forecast. . . .

. . . . His speech came in the wake of a string of disappointing US economic data in the past month that point to a sharp slowdown in the second half of the year.

Earlier on Friday the US Commerce revised its estimate of second quarter GDP growth down to 1.6%, although this cut was much lower than most Wall Street analysts had expected. . . .

. . . ."The issue at this stage is not whether we have the tools to help support economic activity and guard against disinflation [a falling rate of inflation]," Mr Bernanke said.

He said the unorthodox policy options each contained risks and would only be used if the outlook worsened further.

Policy Option Pro Con

1. Quantatitive easing (buying up debts).
Worked during the crisis. Holds down long-term borrowing costs.
Hard to quantify effect, and may be less effective when markets are not under stress. Markets may worry about whether the Fed can safely exit its investments. Inflation risk.

2. Communication (promising to keep rates low for longer, or until certain conditions are met).
Should lower longer term interest rates.
Promises cannot be binding, and conditions for raising rates may be hard to pin down.

3. Paying zero interest on banks' excess reserves at the Fed.
Interest rate cuts are well understood.
The effect on borrowing costs would be small (0.1%-0.15%). A zero rate could undermine the functioning of money markets.

4. Targetting a higher inflation rate.
Could help reverse a prolonged period of deflation (falling prices) like in Japan.
Not popular at the Fed. Makes inflation expectations more uncertain. US is not in deflation yet, and the risk is low.

Mr Bernanke was keen to emphasise the apparent success of earlier quantitative easing - including the purchase of $1.25 trillion worth of mortgage debt - in lowering borrowing costs.

The Fed already decided to extend this policy on 10 August, when it announced that any mortgage repayments it received on its investment would be reinvested in US government bonds.

Other options included reducing to zero the interest paid on excess reserves held by banks with the Fed, and committing to maintain rates low for a longer period.

He also discussed the option of raising the Fed's inflation target - something proposed by some economists - though he said it had no support at the Fed.

In his review of the US economy, Mr Bernanke expressed particular surprise at the rise in the savings rate of US consumers, and the sharp rise in the US trade deficit.

He also noted that business investment in structures - such as commercial real estate - had failed to rebound.

In order for the recovery to be sustained, he said, consumer spending and business investment needed to pick up more quickly.
(Isn't that the point business and the consumer lack sufficient demand to make the economy go.)

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