WASHINGTON (MNI) – The following is the second of four sections of
the remarks of Federal Reserve Chairman Ben Bernanke prepared for
Friday’s Sixth European Central Bank Central Banking Conference in

The Federal Reserve’s policy target for the federal funds rate has
been near zero since December 2008, so another means of providing
monetary accommodation has been necessary since that time. Accordingly,
the FOMC purchased Treasury and agency-backed securities on a large
scale from December 2008 through March 2010, a policy that appears to
have been quite successful in helping to stabilize the economy and
support the recovery during that period. Following up on this earlier
success, the Committee announced this month that it would purchase
additional Treasury securities. In taking that action, the Committee
seeks to support the economic recovery, promote a faster pace of job
creation, and reduce the risk of a further decline in inflation that
would prove damaging to the recovery.

(2 Unexpectedly high realizations of real interest rates increase
the real burden of household and business debts, relative to what was
anticipated when the debt contracts were signed. Higher expected real
interest rates deter capital investment and other forms of spending.)

Although securities purchases are a different tool for conducting
monetary policy than the more familiar approach of managing the
overnight interest rate, the goals and transmission mechanisms are very
similar. In particular, securities purchases by the central bank affect
the economy primarily by lowering interest rates on securities of longer
maturities, just as conventional monetary policy, by affecting the
expected path of short-term rates, also influences longer-term rates.
Lower longer-term rates in turn lead to more accommodative financial
conditions, which support household and business spending. As I noted,
the evidence suggests that asset purchases can be an effective tool;
indeed, financial conditions eased notably in anticipation of the
Federal Reserve’s policy announcement.

Incidentally, in my view, the use of the term “quantitative easing”
to refer to the Federal Reserve’s policies is inappropriate.
Quantitative easing typically refers to policies that seek to have
effects by changing the quantity of bank reserves, a channel which seems
relatively weak, at least in the U.S. context. In contrast, securities
purchases work by affecting the yields on the acquired securities and,
via substitution effects in investors’ portfolios, on a wider range of

This policy tool will be used in a manner that is measured and
responsive to economic conditions. In particular, the Committee stated
that it would review its asset-purchase program regularly in light of
incoming information and would adjust the program as needed to meet its
objectives. Importantly, the Committee remains unwaveringly committed to
price stability and does not seek inflation above the level of 2 percent
or a bit less that most FOMC participants see as consistent with the
Federal Reserve’s mandate. In that regard, it bears emphasizing that the
Federal Reserve has worked hard to ensure that it will not have any
problems exiting from this program at the appropriate time. The Fed’s
power to pay interest on banks’ reserves held at the Federal Reserve
will allow it to manage short-term interest rates effectively and thus
to tighten policy when needed, even if bank reserves remain high.
Moreover, the Fed has invested considerable effort in developing tools
that will allow it to drain or immobilize bank reserves as needed to
facilitate the smooth withdrawal of policy accommodation when conditions
warrant. If necessary, the Committee could also tighten policy by
redeeming or selling securities.

The foreign exchange value of the dollar has fluctuated
considerably during the course of the crisis, driven by a range of
factors. A significant portion of these fluctuations has reflected
changes in investor risk aversion, with the dollar tending to appreciate
when risk aversion is high. In particular, much of the decline over the
summer in the foreign exchange value of the dollar reflected an
unwinding of the increase in the dollar’s value in the spring associated
with the European sovereign debt crisis. The dollar’s role as a safe
haven during periods of market stress stems in no small part from the
underlying strength and stability that the U.S. economy has exhibited
over the years. Fully aware of the important role that the dollar plays
in the international monetary and financial system, the Committee
believes that the best way to continue to deliver the strong economic
fundamentals that underpin the value of the dollar, as well as to
support the global recovery, is through policies that lead to a
resumption of robust growth in a context of price stability in the
United States.

In sum, on its current economic trajectory the United States runs
the risk of seeing millions of workers unemployed or underemployed for
many years. As a society, we should find that outcome unacceptable.
Monetary policy is working in support of both economic recovery and
price stability, but there are limits to what can be achieved by the
central bank alone. The Federal Reserve is nonpartisan and does not make
recommendations regarding specific tax and spending programs. However,
in general terms, a fiscal program that combines near-term measures to
enhance growth with strong, confidence-inducing steps to reduce
longer-term structural deficits would be an important complement to the
policies of the Federal Reserve.

Global Policy Challenges and Tensions

The two-speed nature of the global recovery implies that different
policy stances are appropriate for different groups of countries. As I
have noted, advanced economies generally need accommodative policies to
sustain economic growth. In the emerging market economies, by contrast,
strong growth and incipient concerns about inflation have led to
somewhat tighter policies.

Unfortunately, the differences in the cyclical positions and policy
stances of the advanced and emerging market economies have intensified
the challenges for policymakers around the globe. Notably, in recent
months, some officials in emerging market economies and elsewhere have
argued that accommodative monetary policies in the advanced economies,
especially the United States, have been producing negative spillover
effects on their economies. In particular, they are concerned that
advanced economy policies are inducing excessive capital inflows to the
emerging market economies, inflows that in turn put unwelcome upward
pressure on emerging market currencies and threaten to create asset
price bubbles. As is evident in figure 6, net private capital flows to a
selection of emerging market economies (based on national balance of
payments data) have rebounded from the large outflows experienced during
the worst of the crisis. Overall, by this broad measure, such inflows
through the second quarter of this year were not any larger than in the
year before the crisis, but they were nonetheless substantial. A
narrower but timelier measure of demand for emerging market assets —
net inflows to equity and bond funds investing in emerging markets,
shown in figure 7 suggests that inflows of capital to emerging market
economies have indeed picked up in recent months.

To a large degree, these capital flows have been driven by
perceived return differentials that favor emerging markets, resulting
from factors such as stronger expected growth — both in the short term
and in the longer run — and higher interest rates, which reflect
differences in policy settings as well as other forces. As figures 6 and
7 show, even before the crisis, fast-growing emerging market economies
were attractive destinations for cross-border investment. However,
beyond these fundamental factors, an important driver of the rapid
capital inflows to some emerging markets is incomplete adjustment of
exchange rates in those economies, which leads investors to anticipate
additional returns arising from expected exchange rate appreciation.

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** Market News International Washington Bureau: 202-371-2121 **

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