–Must Balance Benefits Of Non-Traditional Tools Against Costs,Risks

By Brai Odion-Esene

WASHINGTON (MNI) – Federal Reserve Chairman Ben Bernanke believes
there is still room for the central bank to act and support the flagging
U.S. economic recovery, but with interest rates close to zero, he
believes any additional support will have to come via non-traditional
policy actions.

In an Aug. 22 letter to House Oversight Committee Chairman Darrell
Issa obtained by MNI Friday, Bernanke argued that “there is scope for
further action by the Federal Reserve to ease financial conditions and
strengthen the recovery.”

“The monetary accommodation provided by the Federal Reserve has
substantially helped the U.S. economy by easing financial conditions
relative to the conditions that would have prevailed otherwise,” he
said.

Bernanke also made it clear that “monetary policy must necessarily
be set in light of a forecast of the future performance of the economy.”

The Fed chairman was responding to a letter from Issa dated Aug. 1,
in which the congressman asked that given the “extraordinarily” low
interest rate across the entire Treasury yield curve, can further easing
“cure” the nation’s sluggish growth and stubbornly high unemployment
rate.

Bernanke said that with short-term interest rates at historically
low levels, “additional monetary accommodation requires the use of
nontraditional policy tools, such as balance sheet actions or
communication about the likely future course of policy.”

He cautioned, however, that “the expected benefits of these tools
need to be balanced against their potential costs and risks when the
Federal Open Market Committee decides whether additional action is
appropriate.”

Still, he said the Fed is confident that it possesses the tools to
normalize monetary policy “at the appropriate time” as the strength of
the recovery grows.

Bernanke included his now oft-stated opinion that monetary policy
is not a cure-all, and stressed the need for policymakers “in many
different arenas” to carefully examines steps they could take to foster
“a more vigorous recovery.”

Bernanke went on to launch a staunch defense of the Fed’s actions
to-date to support the recovery, particularly its asset purchase
programs.

“By putting downward pressure on longer-term interest rates and
contributing to a broader easing in financial market conditions, these
asset purchases have helped to promote a stronger recovery than
otherwise would have occurred,” he said, adding that the Fed’s buys have
also forestalled “the possibility of a slide into deflation.”

Bernanke said the easing in financial conditions has promoted
economic activity through a variety of channels — including lowering
the cost of capital, boosting the aggregate wealth of U.S. households,
and improving the competitiveness of U.S. businesses abroad.

He noted that the initial phase of the Fed’s maturity extension
program — also known as ‘Operation Twist’ — is still working its way
through the economic system, adding that changes in monetary policy take
several quarters to achieve their full effect on economic activity.

The Operation Twist program was extended at the June meeting of the
Fed’s policymaking Federal Open Market Committee, and Bernanke said this
is still in the “very early phases” of having its effect on the economy.

“Because monetary policy actions operate with a lag, the stance of
policy must necessarily be set in light of a forecast of the future
performance of the economy,” he reiterated.

Bernanke added that “policymakers aim to ensure that the stance of
policy is appropriate, given the latest indicators regarding the state
of the economy and the health of the financial system.”

Many opponents of additional action by the Fed have cited future
inflation risk as a reason the central bank should stand pat, Bernanke
assured lawmakers in the letter that the FOMC is “keenly attuned” to the
risks of inflation and other factors that could affect the future
performance of the economy.

As for the now-constant accusation that the Fed’s actions are
hurting savers, Bernanke responded that an economy performing at its
highest level benefits everyone.

“The returns to long-term investment depend critically on the
vitality of economic activity, the pace of inflation, and the stability
of the financial system,” he said. “The Federal Reserve is striving to
promote these factors that bear so critically on economic well-being.”

** MNI Washington Bureau: 202-371-2121 **

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