The Bernanke Press Conference: What it Tells Me

September 13, 2012

The return to quantitative easing was driven by disappointment over the rate of labor market improvement.  Fed officials are looking at the totality of labor market data, not just the jobless rate and growth of employment but also the participation rate, the length of long-term unemployment, the full time/part time composition of unemployment and estimates about how much of the problem is structural and how much reflects too little demand. 

Fed officials recognize that monetary policy is not necessarily the best tool for promoting labor market improvement, but their empirical research suggests that unconventional policy tools like asset buying have a net beneficial effect.  This finding in conjunction with a congressional mandate to maximize employment as well as preserve price stability obligates the central bank to respond to labor market underperformance.  By the notion of improvement, a sustained pick-up in the labor market is sought.  The consistency of actual and expected future improvement is more important than the speed of the transformation.  Bernanke cautioned against a premature termination of stimulus before the trend seems “well established.”

Fed officials were not unanimously agreed that today’s actions should have been adopted, but Chairman Bernanke asserted that a broad consensus existed in favor of the initiatives.  Of 17 voting members today, 12 thought the most appropriate year to begin raising the fed funds rate is likely to be 2015 versus 4 who preferred this year or next, two who chose 2014, and one who thought 2016 was best.  The preferred end-2015 fed funds rate on the whole committee had an average value of 1.0%.

The most novel element of today’s decisions, unlike earlier episodes of quantitative easing and other policies like Operation Twist, is that no explicit date for stopping the operations was given.  Instead, termination will be a qualitative function of perceived labor market improvement.  So while the starting amount of outright agency mortgage-backed securities to be bought each month and the total planned net monthly increase in central bank holdings of longer-term securities are on a smaller scale than earlier quantitative infusions, the lack of target end-point and the stated readiness to take more forceful action if the labor market does not improve sufficiently magnifies the potential commitment to today’s announced stimulus.  It also transforms what markets can expect.  Without saying as much, Bernanke adopted a page from the ECB President Draghi’s playbook:  the Fed will offer as much as it takes.  Of course, a big difference is that just 16 months remain in Bernanke’s current term as Chairman, whereas Draghi has seven more years on his contract. 

Bernanke did not deny that the Fed’s tools are limited or that other government actions could more effectively address the economy’s deficient growth and lackluster labor market.  The possibility of the fiscal cliff is one of these.  While Bernanke expects something to happen to prevent that, he conceded that monetary policy tools would be no match for the drag of the fiscal cliff.  He also accepted the notion that the mere possibility of a fiscal cliff is partly responsible for the growth slowdown seen in 2012. 

To those questioning the channel by which quantitative easing might promote faster GDP growth, the chairman noted that today’s actions are intended to lower long-term interest rates, and even more directly, stimulate the housing sector, which is usually instrumental in the early stages of recoveries.  Moreover, stronger share prices produce a sense of greater financial security for some, and those people will be readier to spend on a whole lot of consumer items.  If this sounds like a variation on trickle down, well to an extent it is.

New macroeconomic forecasts published today by the Fed are not shockingly more bearish than those from June.  In fact, next year’s projected GDP growth range was bumped up to 2.5-3.0% from 2.2-2.8%.  Plus, PCE inflation was bumped up marginally as well to 1.6-2.0% from 1.5-2.0%.  Importantly, the 2014 and 2015 inflation forecasts also have a 2.0% ceiling and a sub-2.0% target midpoint.  Consequently, officials have a notion of inflation that is not jeopardized in the future by what was done today.  The concept of an output gap was not mentioned explicitly arose in so many words to explain that in an economy that is starting from a position of considerable slack in the use of productive resources, it is possible and even preferable for GDP to expand faster-than-trend for a while.  The labor market will improve, and inflation will not worsen as a trade-off while that negative output gap is being shrunk. 

There were many questions about the future and the commitment of policy whose answer Bernanke could not quantify.  The amount of policy stimulus will be dictated by economic conditions.  If inflation becomes problematic, all bets are off, and the punch bowl will presumably be withdrawn.  If the labor market responds well, less stimulus will be necessary.  If the economy responds very weakly, more support and longer support will be done, presuming that inflation complies.  To critics like Allan Meltzer who claim that because of lags one cannot afford to wait and see if inflation accelerates, it can be pointed out that even if the lag is 2-3 years, Fed easing began early in the second half of 2007 and became massive by 2009, still some 3-1/2 years ago.  Inflation by now should have been much higher than it in fact is given the fiscal and monetary policy backdrops.  As a predictor of the future, the Fed hasn’t been perfect, but the forecasts of its naysayers have been very wide of the mark.  Clearly, the field of economics is overstocked from an ideological perspective and has more ambiguity than the quants would have us think.  The Fed has two choices in the face of an undeniable labor market problem it is legally charged to correct: do nothing and pass the buck to the congress or do something because somebody’s got to take a little initiative.  Today it made a reasonable and very human choice.

Copyright 2012, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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