Unusual times call for Bernanke measures
July 26, 2009
By Ann Woolner
Ben Bernanke wasn't taking any chances. He took his message directly to the people. On the same day the Federal Reserve chairman was to present the bank's semi-annual monetary policy report to Congress, Bernanke outlined the Fed's exit strategy in a Wall Street Journal oped, effectively pre-empting himself.
At least he knew his audience would be listening, which is not something one can say with any assurance about his congressional inquisitors.
There is something to be said for this direct strategy. Bernanke's appearance on 60 Minutes in March showed us another side of the former academic thrust into the role of global crisis manager. We got a glimpse of his humble, small-town roots and a window into his soul, as former president George W Bush might have said. The public liked what it saw.
Today, Bernanke will take questions on the economy at a town-hall meeting moderated by PBS's Jim Lehrer. Excerpts will air tomorrow, Tuesday and Wednesday.
The oped by Bernanke, coming as a surprise on the same day as his congressional testimony, would seem like a natural outgrowth of this strategy of talking to the people at a time when the central bank has used non-traditional measures to stabilise the financial system.
In Tuesday's testimony to the House Financial Services Committee, he stressed the need to keep the overnight interbank rate, currently near zero, "at exceptionally low levels for an extended period".
More importantly, in both forums he said the Fed had "the necessary tools" to withdraw the policy accommodation "in a smooth and timely manner" when it's appropriate.
Those tools include raising the interest rate the Fed pays on reserve balances, which reduces the incentive to lend them out (at a lower risk-adjusted rate) or dump them into the interbank market, which would complicate efforts to raise the funds rate. Then there's the old-fashioned way of tightening policy: open-market operations.
The Fed can sell some of the assets it purchased, or conduct reverse repurchase agreements, which have the effect of draining reserves from the banking system on either a permanent or temporary basis.
All things equal, outright sales would have the effect of lowering the price and raising the yield of those assets, including Treasury and mortgage-backed securities. That might have Congress squawking about higher mortgage rates but if the economy is healthy enough to withstand less accommodating monetary policy it will be able to absorb the higher rates.
The sheer size of the Fed's balance sheet has created concerns about the potential for inflation down the road. It ballooned to $2.3 trillion (R17.5 trillion) in mid-December, from $900 billion last July, before the Fed stepped up its role of lender of last (and only) resort, and has been hovering at about $2 trillion.
Banks are currently holding $744bn of excess reserves, the result of the Fed stuffing them into the banking system to pay for asset purchases.
The whole point in emphasising exit strategies, according to the ISI Group's Tom Gallagher and Andy Laperriere, is to keep inflation expectations anchored.
Those expectations have been creeping up from close to zero at the turn of the year to close to 2 percent, depending on which measure one uses.
Anyone reading Bernanke's oped or listening to his testimony would understand the Fed has the tools to unwind its balance sheet once the financial system is self- sustaining.
The surge in the monetary base, which consists of currency and bank reserves, does not necessarily translate into broad money growth. (Republican Congressman Ron Paul, the Texas libertarian who would like to do away with the Fed, wasn't buying.)
What Bernanke didn't address - something perhaps no central banker can address - is the political will to use those tools, even in the face of rising unemployment.
Monetary policy operates with long and variable lags. To be effective, the Fed has to act pre-emptively. That means acting on the basis of a forecast, the record of which - both the forecast and acting part - is not good.
The depth, breadth and length of the current recession, the distress to the financial system and concerns about a protracted period of deflation, argue for the Fed staying on hold longer than is necessary.
Policy makers have the means, motive and opportunity. Whether they pull the trigger when the time comes is another story.
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