Ben Bernanke is a popular guy right now. As chairman of the U.S. Federal Reserve, he has been in the media spotlight since he took the oath in 2006. In the wake of the financial crisis in 2008, that spotlight focused itself into a laser, and Bernanke’s been cooking in the heat for half a decade.
This week, Bernanke submitted the July 2013 issue of the biannual Monetary Policy Report and testified before both the House Financial Services Committee and the Senate Committee on Banking, Housing, and Urban Affairs. The testimony provided members of Congress with the opportunity to put questions to the chairman about the financial stability of the United States, economic outlook, and about how the Fed plans to conduct monetary policy going forward.
Initial market reaction to Bernanke’s testimony before the House on Wednesday was positive, as the chairman articulated a dynamic and accommodative monetary policy aimed at servicing the Fed’s dual mandate of maximum employment and price stability. On Thursday, he seemed to drive his point home — assisted by strong corporate earnings, the Dow Jones Industrial Average broke a new intraday high.
So what did Bernanke have to say that the market found encouraging?
1) Economic growth is expected to pick up in the near term
Bernanke began his testimony with an overview of the economic outlook for the United States. In a word (the same one that has been used in most statements issued by Fed board members and regional presidents), the recovery has been “moderate.”
In May, San Francisco Fed President John Williams delivered a speech on monetary policy and economic outlook that outlined one basic idea: We’re heading in the right direction. He offered this image to the audience: “Overall, if we were in a car, you might say we’re motoring along, but well under the speed limit. The fact that we’re cruising at a moderate speed instead of still stuck in the ditch is due in part to the Federal Reserve’s unprecedented efforts to keep interest rates low. We may not be getting there as fast as we’d like, but we’re definitely moving in the right direction.”
To torture the metaphor: If the economy were a car, Congress would be in the driver’s seat and the U.S. Federal Reserve would be behind it, pushing. We haven’t been running on internal combustion since 2008.
However, that could be changing. As Bernanke points out in his testimony, most Federal Open Market Committee participants see real GDP growth “beginning to step up during the second half of this year, eventually reaching a pace between 2.9 and 3.6 percent in 2015.”
Pretty much any time Bernanke or the Monetary Policy Report make reference to the economy’s “moderate” recovery, they qualify the statement with some iteration of “despite the strong headwinds created by federal fiscal policy”; forecasts for increased economic growth in the near term assume that “federal fiscal policy will exert somewhat less drag over time, as the effects of the tax increases and the spending sequestration diminish.”
Generally speaking, expansionary fiscal policy — when the government spends more and taxes less — stimulates the economy. Typically, governments take an expansionary position during recessions to spur growth even if it means borrowing money. Proponents of this strategy would rather grow the economy now and pay back the debt later.
U.S. fiscal policy was rather expansionary at the onset of the recession. However, as the Economic Stimulus Act of 2008, the American Recovery and Reinvestment Act of 2009, and the Tax Relief Act all wound down toward 2011, policy quickly became contractionary. This shift toward contractionary fiscal policy was assisted by a legislative push to reduce the deficit and balance the federal budget.
“But,” as Fed Vice Chair Janet Yellen commented in February, “instead of contributing to growth…discretionary fiscal policy this time has actually acted to restrain the recovery.”
3) Monetary policy is flexible and will remain accomodative in the near term
“With unemployment still high and declining only gradually, and with inflation running below the Committee’s longer-run objective, a highly accommodative monetary policy will remain appropriate for the foreseeable future,” Bernanke commented in his testimony.
This accomodative policy includes keeping the target federal funds rate in a range between 0 and 0.25 percent as long as unemployment remains about 6.5 percent and inflation expectations one to two years out remains below 2.5 percent. It also includes the purchase of agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasuries at $45 billion per month.
“The Committee has reiterated that the purchase program will continue until the outlook for the labor market has improved substantially in a context of price stability,” the Monetary policy Report says. “In addition, the FOMC has indicated that the size, pace, and composition of purchases will be adjusted in light of the Committee’s assessment of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives.”
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