By Steven K. Beckner
The third option would be for the FOMC to cut the IOER from 25
basis points or even zero to try to “provide banks with an incentive to
increase their lending to nonfinancial borrowers or to participants in
short-term money markets, reducing short-term interest rates further and
possibly leading to some expansion in money and credit aggregates.”
But he made clear he is skeptical of that approach, saying that
“under current circumstances, the effect of reducing the IOER rate on
financial conditions in isolation would likely be relatively small.”
“The federal funds rate is currently averaging between 15 and 20
basis points and would almost certainly remain positive after the
reduction in the IOER rate,” he said. “Cutting the IOER rate even to
zero would be unlikely therefore to reduce the federal funds rate by
more than 10 to 15 basis points. The effect on longer-term rates would
probably be even less, although that effect would depend in part on the
signal that market participants took from the action about the likely
future course of policy.”
“Moreover,” he said, “such an action could disrupt some key
financial markets and institutions. Importantly for the Fed’s purposes,
a further reduction in very short-term interest rates could lead
short-term money markets such as the federal funds market to become much
less liquid, as near-zero returns might induce many participants and
market-makers to exit.”
As for increasing the Fed’s inflation target in order to increase
inflation expectations and head off disinflationary or deflationary
pressures, Bernanke sounded even more skeptical.
“I see no support for this option on the FOMC,” he said.
“Conceivably, such a step might make sense in a situation in which
a prolonged period of deflation had greatly weakened the confidence of
the public in the ability of the central bank to achieve price
stability, so that drastic measures were required to shift
expectations,” he said, but added, “such a strategy is inappropriate for
the United States in current circumstances” because “inflation
expectations appear reasonably well-anchored, and both inflation
expectations and actual inflation remain within a range consistent with
price stability.”
Whatever tool is used, if at all, Bernanke said the “benefits and
drawbacks … must be appropriately balanced.”
He stressed that “at this juncture, the Committee has not agreed on
specific criteria or triggers for further action.”
But he laid out broad conditions under which additional monetary
stimulus steps might be taken:
“First, the FOMC will strongly resist deviations from price
stability in the downward direction. Falling into deflation is not a
significant risk for the United States at this time, but that is true in
part because the public understands that the Federal Reserve will be
vigilant and proactive in addressing significant further disinflation.
It is worthwhile to note that, if deflation risks were to increase, the
benefit-cost tradeoffs of some of our policy tools could become
significantly more favorable.”
“Second, regardless of the risks of deflation, the FOMC will do all
that it can to ensure continuation of the economic recovery. Consistent
with our mandate, the Federal Reserve is committed to promoting growth
in employment and reducing resource slack more generally. Because a
further significant weakening in the economic outlook would likely be
associated with further disinflation, in the current environment there
is little or no potential conflict between the goals of supporting
growth and employment and of maintaining price stability.”
Bernanke prefaced his discussion of possibile additional monetary
accommodation with what amounted to a downgrading of his view of the
economy.
He began by recalling that at the Jackson Hole conference a year
ago “there were strong indications that the sharp contraction of the
global economy of late 2008 and early 2009 had ended. Most economies
were growing again, and international trade was once again expanding.”
A year later, he said, “for much of the world, the task of economic
recovery and repair remains far from complete.”
“In many countries, including the United States and most other
advanced industrial nations, growth during the past year has been too
slow and joblessness remains too high,” he said. “Financial conditions
are generally much improved, but bank credit remains tight….”
What’s more, he said, “managing fiscal deficits and debt is a
daunting challenge for many countries, and imbalances in global trade
and current accounts remain a persistent problem.”
Last year’s fiscal stimulus package and turn-of-the-year inventory
rebuilding could provide only a temporary impetus to growth, he said.
“For a sustained expansion to take hold, growth in private final
demand–notably, consumer spending and business fixed investment–must
ultimately take the lead.”
Bernanke said that “on the whole, in the United States, that
critical handoff appears to be under way.”
“However,” he added, “although private final demand, output, and
employment have indeed been growing for more than a year, the pace of
that growth recently appears somewhat less vigorous than we expected.”
He said job growth has been “painfully slow” and said unemployment
is likely to come down “only slowly” because firms are “reluctant to add
permanent employees.”
He called unemployment a “central concern” for the Fed.
Reiterating another of his oft-cited “headwinds,” Bernanke said
credit for households remains tight. And he said consumers have become
“even more cautious…than previously believed.”
Bernanke also pointed to “depressed” housing markets and warned
that “the overhang of foreclosed-upon and vacant housing and the
difficulties of many households in obtaining mortgage financing are
likely to continue to weigh on the pace of residential investment for
some time yet.”
He said business investment in equipment and software “will almost
certainly increase more slowly over the remainder of this year” and he
said “a divide has opened between large firms that are able to tap
public securities markets and small firms that largely depend on banks.”
“Bank-dependent smaller firms, by contrast, have faced
significantly greater problems obtaining credit,” he said.
“Overall, the incoming data suggest that the recovery of output and
employment in the United States has slowed in recent months, to a pace
somewhat weaker than most FOMC participants projected earlier this
year,” he said. “I expect the economy to continue to expand in the
second half of this year, albeit at a relatively modest pace.”
Looking ahead, Bernanke said “the preconditions for a pickup in
growth in 2011 appear to remain in place.”
But Bernanke was not brimming with optimism.
“Although output growth should be stronger next year, resource
slack and unemployment seem likely to decline only slowly,” he said.
“The prospect of high unemployment for a long period of time remains a
central concern of policy.”
He said high unemployment “poses risks to the sustainability of the
recovery itself through its effects on households’ incomes and
confidence.”
Bernanke said “maintaining price stability is also a central
concern of policy,” and he noted that “recently, inflation has declined
to a level that is slightly below that which FOMC participants view as
most conducive to a healthy economy in the long run.”
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** Market News International **
[TOPICS: M$U$$$,MMUFE$,MGU$$$,MFU$$$,MT$$$$]
