Outgoing Fed Chairman Ben Bernanke spoke at the National Economists Club Annual Dinner in Washington, D.C. on Nov. 19. Since the Herbert Stein Memorial Lecture may be one of the last speeches by one of the most influential Fed Chairman; Martin McGuire, managing director at TJM Institutional Services and fervent Fed watcher, decided to breakdown the speech and translate it from Fedese.
Communication and Monetary Policy
10.) Nearly eight years ago, when I began my time as Chairman, one of my priorities was to make the Federal Reserve more transparent--and, in particular, to make monetary policy as transparent and open as reasonably possible.
*Monetary Policy was already too transparent in the ‘restrictive’ policy regime. By giving the public and markets too much guidance about future monetary policy plans (‘measured pace’ 17 times), excesses in credit creation and mal-investment were the outcome, proving all too clearly that transparency in monetary policy works best in accommodative (easy) policy regimes.
9.) This increased transparency about the framework of policy has aided the public in forming policy expectations, reduced uncertainty, and made policy more effective.
*More and more, the Fed is demonstrating a growing understanding of its potential to influence the level of ‘uncertainty’ and the benefit for reduced uncertainty to add to levels of economic growth. The importance of affecting ‘certainties’ cannot be overstated…especially as relates to the benefits for promoting growth in a recession.
8.) As my colleagues and I have frequently emphasized, the conditions stated in this guidance are thresholds, not triggers. Crossing one of the thresholds will not automatically give rise to an increase in the federal funds rate target; instead, it will signal only that it is appropriate for the Committee to begin considering whether an increase in the target is warranted.
*Said many times in the past, but as relates to set-up for Yellen, is an important restatement. It also implies less chance for an unemployment threshold drop from 6.5%.
7.) However, after the unemployment threshold is crossed, many other indicators become relevant to a comprehensive judgment of the health of the labor market, including such measures as payroll employment, labor force participation, and the rates of hiring and separation. In particular, even after unemployment drops below 6.5%, and so long as inflation remains well behaved, the Committee can be patient in seeking assurance that the labor market is sufficiently strong before considering any increase in its target for the federal funds rate.
*Again, consistent with earlier language, its repetition following the release of Fed staff papers suggesting possible benefit from lowering unemployment threshold reduces the likelihood for a change of that threshold.
6.) Forward rate guidance affects longer-term interest rates primarily by influencing investors' expectations of future short-term interest rates. LSAPs, in contrast, most directly affect term premiums. As the Federal Reserve buys a larger share of the outstanding stock of longer-term securities, the quantity of these securities available for private-sector portfolios declines. As the securities purchased by the Fed become scarcer, they should become more valuable. Consequently, their yields should fall as investors demand a smaller term premium for holding them. This argument depends importantly on the assumption that the longer-term Treasury and MBS securities that the Fed buys are not perfectly substitutable with other types of assets, an assumption that seems well supported in practice.
*To the extent forward guidance of policy rates promotes a confidence about future short-term interest rate levels and about expected variance about those expected future short rates, it has a VERY strong impact on Term Premium.