Bernanke made a speech this morning to other central bankers, economists and journalists at an annual forum in Jackson Hole. There were a number of key phrases Fed watchers were expecting to hear and, hopefully, not hear. And here’s the tally. Bernanke used some variation of the work “slow” seven times. So, as expected, Bernanke was trying to make the point that he believes the recovery is turning out to be weaker than expected. Here a piece from the conclusion of his speech:
In sum, the pace of recovery in output and employment has slowed somewhat in recent months, in part because of slower-than-expected growth in consumer spending, as well as continued weakness in residential and nonresidential construction. Despite this recent slowing, however, it is reasonable to expect some pickup in growth in 2011 and in subsequent years.
Bernanke wants to make the case that it is right to leave interest rates near zero for the rest of this year and beyond. So he is doing his best to convince people the economy, as he sees it, is weak. As to how long rates will stay low, he only used the phrase “extended” twice. That was another one of those buzz terms I was looking for. How do I read that?
I don’t think that means Bernanke is planning on raising rates soon. What I think it means is that Bernanke is trying to take the focus away from rate policy and toward the other methods of stimulus that he is contemplating. One of the things that I think could be a good way for the Fed to boost bank lending is to end interest payments on bank reserve kept at the Fed. Bernanke talked about that option, but he questioned how much effect lowering the IOER rate (which is what it is technically called) would have on bank lending.
On the margin, a reduction in the IOER rate would 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. However, under current circumstances, the effect of reducing the IOER rate on financial conditions in isolation would likely be relatively small.
Ben, we will have to agree to disagree.
Bernanke did say that he thinks the Fed Reserve in the future will have to buy more long-dated Treasury bonds and other securities. That’s another way the Federal Reserve can boost the economy and increase lending. By buying bonds, the Federal Reserve puts more money into the system and at the same time makes it cheaper to lend by driving down the interest rates on those bonds. Clearly, the folks over at Calculated Risk think more “quantitative easing,” or QE, which is what it is called when the Fed uses its (or our) money to buy bonds and other investments. They are saying he is planning a new round of quantitative easing or cutely QE2:
I think Bernanke is paving the way for QE2, although he probably feels he needs more evidence of a slowing economy or further disinflation to persuade other members of the FOMC. A warning from a large tech company is probably significant at this point, . . . . Or perhaps the unemployment rate ticking up in the August employment report next Friday might be enough. There will be plenty of data released before the September 21 FOMC meeting (and if the data is weaker, the meeting might be expanded to two days). Or perhaps the FOMC will wait until November, but it does appears Bernanke is preparing everyone for QE2.
The big surprise in the speech was how many times he mentioned deflation. The D-word popped up six times in his speech. Still I don’t think that means deflation is coming. Here’s why:
You don’t go around dropping the D-word unless you have to. So clearly, Bernanke believes the chances of prices falling is a credible threat to the economy. Or at least he thinks some credible people think the chances of deflation are rising. In fact, a number of large hedge funds have been placing bets that deflation could happen. How credible? Well, I wouldn’t hold off back to school shopping for new. One measure is the ratio of times he used inflation to deflation. The word “inflation” popped up 30 times in the speech. That’s five inflations for every one deflation. But just comparing the number of times he used deflation to inflation is not fair. Inflation is something that is always part of the Federal Reserve language. And being that inflation is nearly always present you would expect him to address it. Deflation is rare, freak occurrence. So I still think the fact that he used 6 times could be seen as meaningful.
Here’s what Bernanke said about deflation:
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.
So he really didn’t propose a new strategy to fight deflation. Just that if deflation were to occur, low interest rates and the other measures the Fed is taking would be the remedy. I think that is a little coy. If Bernanke were really worried about deflation he would be open to raising the Federal Reserve inflation policy target. Bernanke did bring up that as a possible policy solution, though not while he was discussing deflation. Still, we can count that as a silent D-word. But he said he wasn’t willing to do that. So again, Bernanke is making the case that deflation is not a problem he is worried about. Nonetheless, the fact that Bernanke did drop the D-word means something. At the very least, deflation is something we are probably going to hear more about in the next few months.