October 15, 2010
By SEWELL CHAN
BOSTON — The Federal Reserve chairman, Ben S. Bernanke, sent a clear signal on Friday that the central bank was poised to take additional steps to try to fight persistently low inflation and high unemployment.
“Given the committee’s objectives, there would appear — all else being equal — to be a case for further action,” he said in a detailed speech at a gathering of economists here.
Mr. Bernanke noted that “unconventional policies have costs and limitations that must be taken into account in judging whether and how aggressively they should be used.” But he suggested that the Fed was prepared to manage the risks associated with the most powerful tool remaining in the Fed’s arsenal of weapons to stimulate the economy: vast new purchases of government debt to lower long-term interest rates.
As Mr. Bernanke sent a message to the markets that the Fed was prepared to wander into uncharted territory, he tried to anticipate and address potential criticism.
“One disadvantage of asset purchases relative to conventional monetary policy is that we have much less experience in judging the economic effects of this policy instrument, which makes it challenging to determine the appropriate quantity and pace of purchases and to communicate this policy response to the public,” he said.
Mr. Bernanke addressed a criticism of new asset purchases, that they would “reduce public confidence in the Fed’s ability to execute a smooth exit from its accommodative policies at the appropriate time.” Such a reduction in confidence, “even if unjustified,” could lead to an undesirable increase in inflation expectations, he said.
For now, inflation appears remote. As Mr. Bernanke spoke, the government released the September figures for the consumer price index, showing a rise of only 0.1 percent from the previous month. The core index, excluding energy and food, was flat.
Mr. Bernanke’s comments in Boston strongly suggested that the Federal Open Market Committee, which sets monetary policy, is likely to take new steps at its next meeting, on Nov. 2-3.
The Fed’s balance sheet has nearly tripled, to about $2.3 trillion, since the financial crisis of 2008. Most of the increase can be attributed to the Fed’s purchases of $1.7 trillion in mortgage-related securities and Treasury securities in 2009-10. The Fed has tested a number of technical tools to drain the large pool of bank reserves that it created in order to purchase those securities.
“With these tools in hand, I am confident that the F.O.M.C. will be able to tighten monetary conditions when warranted, even if the balance sheet remains considerably larger than normal at that time,” Mr. Bernanke said.
Mr. Bernanke also weighed one other tool the Fed could take: communicating that it intends to keep short-term interest rates at nearly zero for even longer than the markets now expect. (The Fed has been saying since March 2009 that the benchmark federal funds rate, at which banks lend to each other overnight, would remain “exceptionally low” for “an extended period.”) Changing the statement could help lower longer-term rates.
“A potential drawback of using the F.O.M.C.’s statement this way is that, at least without a more comprehensive framework in place, it may be difficult to convey the committee’s policy intentions with sufficient precision and conditionality,” Mr. Bernanke said, hinting that that strategy was not his favored approach.
Mr. Bernanke used his speech to plant himself firmly on the side of those who view the high unemployment rate — 9.6 percent — as an outcome of the sharp contraction in economic demand that accompanied the financial crisis, rather than structural factors like a mismatch between workers’ skills and the skills required by employers.
Disappointing some Wall Street analysts, Mr. Bernanke did not reveal details of the magnitude and pace of any new debt purchases — a strategy known as quantitative easing.
Instead, and in line with his background as a professor who taught at Stanford and Princeton until he joined the government in 2002, Mr. Bernanke outlined the intellectual case for new action.
He acknowledged, with greater candor than Fed officials have normally used, the tension between the two parts of the Fed’s dual mandate: promoting price stability and maximum employment.
“Whereas monetary policy makers clearly have the ability to determine the inflation rate in the long run, they have little or no control over the longer-run sustainable unemployment rate, which is primarily determined by demographic and structural factors, not by monetary policy,” Mr. Bernanke said.
Therefore, Mr. Bernanke seemed to frame his argument for new actions more in terms of preventing inflation from getting too low than in terms of improving the job market quickly.
“In light of the recent decline in inflation, the degree of slack in the economy, and the relative stability of inflation expectations, it is reasonable to forecast that underlying inflation — setting aside the inevitable short-run volatility — will be less than the mandate-consistent inflation rate,” Mr. Bernanke said. Mr. Bernanke also came closer than ever before to specifying an explicit inflation target for the Fed, saying that Fed policy-makers “generally judge the mandate-consistent inflation rate to be about 2 percent or a bit below.”
That figure was particularly significant because it lent support to Mr. Bernanke’s argument that inflation is too low. One key measure of inflation — the price index for personal consumption expenditures, which excludes volatile food and energy prices — has fallen from about 2.5 percent in the early stages of the recession to about 1.1 percent over the first eight months of this year, Mr. Bernanke noted.
Mr. Bernanke’s speech followed signals from within the Fed that for all its previous steps to get the economy back on track, new action was needed.
Minutes of the Fed’s most recent policy-making meeting, released this week, showed the members divided between those with the view that the Fed should act “unless the pace of economic recovery strengthened,” and others who thought action was merited “only if the outlook worsened and the odds of deflation increased materially.”
The minutes of the meeting of the Federal Open Market Committee, held Sept. 21, indicated that several officials “consider it appropriate to take action soon,” given persistently high unemployment and uncomfortably low inflation.
But other officials “saw merit in accumulating further information before reaching a decision,” according to the minutes.