Act II: Well-Communicated and Useful Information at the Bernanke Press Conference
April 27, 2011
Bravo to the Fed for introducing press conferences! One generally doesn’t learn much from Bank of Japan press conferences, which are frequent affairs, and the ECB’s staged events are just that, opportunities to run through a checklist of points regardless of what’s asked. Although Chairman Bernanke did not give replies to each question that will satisfy everybody, he didn’t duck any of them. He managed to convey considerable information beyond what has been printed in the post-FOMC statements. In style, he showed a smaller range of emotions that Trichet, dropping the latter’s scornful approach to questions that he doesn’t want to field, but was clearly in command and made no obvious gaffes to rattle investors. To be sure, the dollar was 0.5% weaker at the end of the press conference than at 16:30 GMT when the FOMC statement was release. Gold had jumped $17 or 1.1% over the same span, and the 10-year Treasury yield was a basis point higher. These movements are consistent with a continuing loose monetary policy but do not appear to reflect a lack of confidence in Bernanke or other FOMC members.
There was much to learn, and some questions dealt explicitly with the beleaguered dollar and what the central bank might do if it continues to depreciate. The answer was two-fold. Bernanke correctly point out that the Treasury Secretary, not the Fed, has responsibility over dollar policy but noted his agreement with the Treasury’s view that a strong and stable dollar is in everyone’s interest, supporting the well-being of the United States but also other countries. He added that the best way for the Fed to promote that goal would be to pursue its dual mandate, which the current policy does. Low and stable inflation is a pre-requisite for sustained medium-term recovery. Preserving the interval value of the dollar should help preserve its external value as well, while a policy that also tries to maximize employment should attract dollar-supportive capital inflows. What Bernanke omitted is an explanation for the dollar’s 40-year-long secular decline in spite of comparatively dynamic U.S. economic growth and a pronounced slowdown of inflation since the early 1980s. And to be even more candid, vesting dollar policy with politicians rather than the central bank is a mistake. Exchange rates are the price of ones money. The central bank, not the government, controls the stock of that money — the supply side of the equation. The Fed doesn’t control the demand side, but neither do the politicians. The Fed has the means to deliver a stable and strong dollar and should be the ones with responsibility for that policy.
It became clearer at the outset of the press conference that the FOMC’s notions of long-term tendencies in GDP growth, unemployment, and inflation play a very prominent role in the current ultra-accommodative monetary policy. A designated 1.7-2.0% range for the PCE price deflator essentially defines policymakers’ notion of their mandate of price stability, and they expect such to be met next year and in 2013. The U.S. is structured for 5.2-5.6% unemployment in the long term, still far below the current level or even the anticipated range in 2013. The normal long-term growth rate of 2.5-2.8% is less than expected growth in 2012 and 2013 but not by so much as to absorb the economy’s slack anytime soon. In response to a question about the risk that quantitative easing could build up tinder to overheat the economy and fuel future inflation, Bernanke reverted to a model of policy guidelines that sees the transmission of policy to inflation and growth first reaching financial markets and only then affecting demand and finally inflation. The economic outlook is reassessed every three months and takes into account monetary policy. It’s not a monetarist framework, and the presumption is that appropriate lead time will exist to normalize policy, reduce the Fed’s balance sheet, and keep inflation anchored.
Expected inflation entered many of Bernanke’s answers, and he distinguished long-term expectations about inflation from short-term ones. Since policy must be oriented toward a time well into the future, it has to rely on the economic outlook and be guided by long-term price expectations. I was disappointed that nobody asked if the spike in gold prices and the drop of the dollar were not in themselves barometers of long-term inflation and evidence that investors are engaged in activities that hedge against the possibility of higher sustained inflation in the long term.
Interesting information was elicited by questions about what the phrase “extended period” exactly means as used in the FOMC statement and when the process of normalization is likely to start.
- If quantitative easing is not extended beyond June, the intent initially will be to replace maturing securities held by the Fed so as not to start shrinking its balance sheet immediately. Doing this will not constitute an easing of policy, since monetary policy is a function of the stock of securities held, not their rate of change.
- An early step in the process of policy normalization will be to allow the balance sheet to shrink as securities mature and are not replaced. When this happens, policy tightening will be underway.
- The vagueness of the term “extended period” was chosen explicitly because it is inexact, and the truth is that policymakers do not know when it will be time to tighten. Such a moment will be determined by the uncertain future evolution of economic conditions and their impact on the economic outlook as Fed policymakers perceive it.
- Trade-offs between promoting employment and preserving low and stable inflation are less attractive now than in March 2009 when QE1 began or at the first suggestion of QE2 in August 2010. People should not underestimate the Fed’s determination to deliver price stability. If that mission fails, the task of winning it back would undermine the Fed’s other mandate of sustainable dynamic growth. Losing price stability even temporarily is not an option as it would in the end jeopardize both of the Fed’s goals.
Bernanke was questioned about fiscal policy but not nearly as much as he typically is when testifying before Congress or as often as Trichet tends to be. He considers a long-range solution to the deficit to be the biggest policy challenge facing the government. He welcomes the shift to a negative ratings outlook by S&P as a galvanizing reality check and is hopeful that a serious and constructive plan will be passed. If not, he flat out predicted a long-term decline in America’s standard of living. If the problem is tackled, however, he sees no reasons why the United States cannot look forward to a faster pace of growth resuming eventually because the structural conditions that gave America its dynamism in the past are still in place. On that point, I tend to disagree.
Finally, Bernanke considers the issue of high long-term unemployment in the United States to be a very serious one. While suggesting that the main ways to reverse the problem lie outside the realm of monetary policy, he said the Fed can help indirectly by pursuing its mandates and conceded that was one reason why the central bank became so inventive in finding ways to promote jobs even after interest rates were near zero. But he also said that long-term unemployment is harder to reverse the longer it is allowed to fester, and that’s one of the reasons I do not share his long-term confidence. The problem is already too big and the source of irreparable harm.
All in all, however, the use of the press conference and the way Bernanke executed that new policy feature were done extremely well on opening night.
Copyright Larry Greenberg 2011. All rights reserved. No secondary distribution without express permission.
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