My, how things have changed on the monetary policy front! Not all that long ago, speculation focused on when the Federal Reserve would start tightening policy. Now, the pendulum has swung and the Fed is actively considering additional monetary easing.
Without adequately preparing the markets, the Fed’s policymaking Federal Open Market Committee (FOMC) decided on Aug. 10 to reinvest proceeds of maturing mortgage backed securities in its portfolio in longer term Treasury securities to halt shrinkage in its balance sheet.
In announcing the change, the Fed said “the pace of recovery in output and employment has slowed in recent months.”
Fed officials have downplayed the significance of the move, but it has to be considered a baby step back toward quantitative easing. Without the decision, Fed staff advised the FOMC that Fed holdings of agency mortgage backed securities would shrink by at least $340 billion by the end of 2011.
The FOMC acted to prevent an inadvertent tightening of credit, something it was prepared to countenance just a month or so earlier before the “summer recovery” faded.
The Fed continues to test its reserve draining tools -- reverse repurchase agreements and the new term deposit facility -- to prepare for the day when it eventually increases reserve pressures and hikes short-term interest rates. The real action lies elsewhere, though.
Further monetary easing will not be automatic, but Fed Chairman Ben Bernanke left no doubt at the Kansas City Fed’s Jackson Hole symposium that he is ready to push for more easing if there is further evidence that the recovery is losing momentum and/or that the risks of excessive disinflation are rising. Bernanke did not pledge additional monetary stimulus, saying the benefits would have to be weighed against the costs. But he did promise to do so if there is “significant” further deterioration in the outlook.
His speech in and of itself was a form of easing. The purpose was clearly to lessen fears of a double dip recession and deflation -- to actually increase inflation expectations and rouse hopes for faster growth.
“Notwithstanding the fact that the policy rate is near its zero lower bound, the Federal Reserve retains a number of tools and strategies for providing additional stimulus...” Bernanke said on the morning when the second quarter gross domestic product (GDP) estimate was revised to 1.6% from 2.4%.
“We will continue to monitor economic developments closely and to evaluate whether additional monetary easing would be beneficial,” he went on. “In particular, the Committee is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly.”
Dallas Fed President Richard Fisher thinks the Fed is doing “as much as is prudent” to stimulate the economy and said it is now up to politicians to “get it right.”
Fisher, who will be an FOMC voter in 2011, says firms in his Fed district are reluctant to hire and invest because they’re unsure about “capricious” tax and regulatory policies. He’s no partisan Republican, having served in the Carter and Clinton administrations. Business reluctance in turn makes Fisher “reluctant to [support renewed quantitative easing] unless or until fiscal and regulatory initiatives are aligned with the needs of job creators.”
But Bernanke will undoubtedly get the support he needs for further stimulus if he wants it, especially with San Francisco Fed President Janet Yellen and other Obama appointees to the Board of Governors due to arrive on the scene once confirmed.
And it probably won’t take a lot -- perhaps a couple more discouraging GDP, employment or core inflation reports.
What kind of move is most likely? Bernanke made clear his preference is renewed asset purchases. He virtually dismissed other options, such as cutting the already meager interest rate on excess reserves and raising the inflation target.
He seemed a bit more amenable to toying with FOMC communications to imply an even longer “extended period” of “exceptionally low” rates. But there has been vocal opposition to the current policy guidance. Minneapolis Fed President Narayana Kocherlakota, another of next year’s FOMC voters, warns that an “extended period” of zero rates may “re-enforce deflationary expectations and lead to many years of deflation.”
That leaves asset purchases, and Bernanke said he “believe(s) that additional purchases of longer-term securities ... would be effective in further easing financial conditions.”
Adding to the balance sheet (not just preventing it from shrinking) has problems of its own, as Bernanke admitted. Namely, it would further complicate the Fed’s eventual exit strategy. But that is the Fed’s most likely course “if the outlook were to deteriorate significantly.”
One of the costs that Bernanke and his colleagues will have to weigh is the risk that additional stimulus measures may do little except further exhaust the Fed’s ammunition because of rampant uncertainty among firms and households.
But, the Fed has a dual statutory mandate to promote maximum employment and price stability, and the FOMC likely will feel bound to try their best with what’s left in their arsenal to achieve those goals.
Steve Beckner is senior correspondent for Market News International, is a regular on National Public Radio and is the author of “Back From The Brink: The Greenspan Years” (Wiley).