One point came through loud and clear Friday in Federal Reserve Chairman Ben S. Bernanke’s closely watched speech: The Fed is setting a very high threshold for further action in the coming months to spur economic growth.
While the Fed chief vowed further action – such as more purchases of long-term securities – if the economy were to deteriorate, it would have to be something dire, such as a renewed decline in payroll employment coupled with a forecast of a very weak 2011. But given the usual inertia in movements of the economy, that means no monetary policy changes are likely for some months to come.
Bernanke offered this largely stand-pat message in a speech at the Kansas City Federal Reserve Bank’s annual policy conference in Jackson Hole, Wyo.
Bernanke said Fed officials are “prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly.” The recent signs of slowing economic growth clearly haven’t reached the “significant” level, he said.
Shortly before Bernanke spoke, the Commerce Department marked down its estimate of second quarter gross domestic product growth to a 1.6 percent annual rate from the 2.4 percent rate reported earlier. Nevertheless, Fed officials still expect economic activity to pick up in 2011 and be at least strong enough to gradually reduce the nation’s 9.5 percent jobless rate, the Fed chairman said.
Stocks closed sharply higher following Bernanke speech in which he was at least open to considering other options if the economic outlook weakened. According to preliminary calculations, the Dow Jones industrial average rose 165, or 1.7 percent, to 10,150. The S&P 500 rose 17, also 1.7 percent, to 1,064. The Nasdaq rose 35, or 1.6 percent, to 2,153. Rising stocks outnumbered falling ones by six to one on the New York Stock Exchange, where volume came to 1.1 billion shares.
The central bank’s major problem is that its key policy tool, changes in the overnight interest rate known as the federal funds rate, is already set at zero to a quarter-percentage point and cannot realistically be cut further. Many financial analysts had expected the Fed chairman to announce some new extraordinary action to stimulate the economy.
That expectation was never very realistic, since the Fed’s top policymaking group, the Federal Open Market Committee (FOMC) found itself very divided over whether to take even the relatively minor step of allowing the assets the Fed owns to shrink over time. Bernanke and his allies within the FOMC persuaded several skeptics to go along with keeping the size of the balance sheet unchanged.
The Fed's Options
In his speech, Bernanke said three options are available if the Fed were to decide more stimulus is necessary -- though each “has benefits and drawbacks,” he noted.
Those options include buying more long-term securities in an effort to reduce already low long-term interest rates; providing more guidance to the public about the Fed’s expectations about changes in its target for overnight interest rates; and reducing the quarter-percentage point interest rate it pays on excess reserves banks keep on deposit at Federal Reserve banks. Currently the drawbacks of each of these options outweigh the benefits, Bernanke indicated.
In an Aug. 26 op-ed article in the Wall Street Journal, former Fed vice chairman Alan Blinder, a Princeton University economics professor, called these options “weak stuff.” However, if need be, the Fed should go ahead and use them, Blinder said.
Bernanke categorically rejected a fourth policy option: an increase in the Fed’s medium-term inflation goal of 1.5 to 2 percent. Paul Krugman, a Princeton economics professor and New York Times columnist, has repeatedly urged the Fed to take that step. In a column in today’s Times, Krugman did not mention reducing interest paid on reserves, but endorsed the other options. Raising the inflation goal would make “it less attractive for businesses to simply sit on their cash,” He said.
“Nobody can be sure how well these measures would work, but it’s better to try something that might not work than to make excuses while workers suffer,” Krugman argued.
Bernanke said that raising the inflation goal might make sense if the United States had had a prolonged period of deflation--that is, years of broadly falling prices. But that hasn’t happened and “such a strategy is inappropriate for the United States in current circumstances,” he said, adding, “I see no support for this option on the FOMC.”
As for the other options, Bernanke said, the FOMC “has not agreed on specific criteria or triggers for further action.” However, an increase in the risk of deflation might do it because “the benefit-cost tradeoffs of some of our policy tools could become significantly more favorable,” he said.
Related links:
Fed Ready to Increase Its Buying of Long-Term Debt (New York Times)
Bernanke: Recovery ‘Less Vigorous’ Than Expected But on Track (Washington Post)
Ben Bernanke Promises to Step in as US Economy Veers Back Towards Recession (The Guardian)