Is Bernanke’s Monetary Policy a Risk or a Fix for the U.S. Economy?
Chairman of the Federal Reserve Ben Bernanke testified before the House Financial Services Committee on Wednesday morning. The 10-second takeaway, a near facsimile of Tuesday’s hearing before the Senate Banking Committee, was that Bernanke remains a champion of quantitative easing. Rolling with the blows dealt by those who disagree with his policies (there are many), Bernanke dug a trench around the idea that the benefits of the Fed’s policy outweigh the risks.
The hearings were broken down into two parts: testimony and a questions and answers portion. Panel testimony at the beginning of the hearings was consciously kept brief under what seemed to be a consensus that the real meat was in Bernanke’s testimony and the Q&A session. As mandated, Bernanke delivered the same testimony before both panels.
The whole thing is worth a read, but it doesn’t really contain any surprises or new insight. In it, Bernanke describes the U.S. economy as expanding at a “moderate if somewhat uneven pace.” In his perspective, flat-to-negative fourth-quarter GDP growth should be interpreted as an effectively seasonal fluctuation, and should not be taken to indicate the beginning of another recessionary period. The fourth-quarter pause in economic activity punctuated about 3 percent annual growth in 2012.
Bernanke’s take is of the of glass-half-full variety, describing the labor market as “improving gradually” though “generally weak.” Some early focus was given to the dual mandate of the Federal Reserve — which states that the FOMC will try to maximize employment and maintain moderate long-term interest rates — and the central bank’s decision to link its policy to these metrics…
Bernanke defended the move, suggesting that pegging Fed policy to labor market conditions (the Fed set a target of 6.5 percent U-3 unemployment, which currently sits at 7.9 percent) and long-term interest rates (no more than 0.5 percent above the long-term goal of 2 percent inflation) allows market participants to more accurately and frequently update their monetary policy expectations.
“With unemployment well above normal levels and inflation subdued, progress toward the Federal Reserve’s mandated objectives of maximum employment and price stability has required a highly accommodative monetary policy,” Bernanke wrote in his testimony. “Under normal circumstances, policy accommodation would be provided through reductions in the FOMC’s target for the federal funds rate–the interest rate on overnight loans between banks. However, as this rate has been close to zero since December 2008, the Federal Reserve has had to use alternative policy tools.”
It’s these other tools that were the focus of much of the questioning Bernanke faced, as well as the national conversation concerning whether or not the Fed’s policy is worth the risk…
If conventional policy fails, it seems tautological that unconventional policy should be adopted. To this point, Bernanke addressed the two main differences of the current, unconventional, policy. The first is forward-looking guidance — i.e. not just linking monetary policy to inflation and labor market conditions, but making that strategy public knowledge — and the second are the highly-controversial rounds of asset-purchases.
At a glance, the goal of purchasing securities is to put downward pressure on longer-term interest rates. The result of easy-money policy is in the name, and the strategy is to make access to cash easy enough that entrepreneurs can afford to borrow in order to take (appropriate amounts of) risk, and big businesses can access the credit they need to grow.
But risks are rampant. Bubbles, distortions that result from difficulties pricing risk, and a “don’t fight the fed” business strategy mentality — specifically, a non-market based business strategy that responds more to the tremendous size of the Fed’s footprint and less to actual real-world market dynamics — are just a few concerns offered by critics of Bernanke’s policies…
Another fear is that retirees have poor incentives to move to or remain in lower-risk investments, because yields are so low. It’s a backwards logic that puts pension funds into volatile equities, and critics would say that easy-money policy incentivizes that reasoning.
The possibility that investors large and small will use the backdrop of the Fed’s policy to take on excessive risk has been a major point of contention in the debate around federal policy. At the end of the day, Bernanke and the majority of his colleagues conclude that the benefits — progress toward the dual mandate — outweigh the risks.
While Bernanke is confident in that claim, critics have questioned his foresight. Remember that he failed to properly diagnose the housing crisis as it was building. Concerns are growing alongside the Fed’s balance sheet that it’s enormous position will be catastrophically difficult to unwind. Bernanke, for his part, believes he can tighten monetary policy when the time is needed.
Don’t Miss: Bernanke Talks Sequestration, Defends the Fed.