For better or worse, U.S. Federal Reserve Chairman Ben Bernanke has become a pillar of the U.S. economic recovery. As the face and primary mouthpiece of the Fed, Bernanke has assumed responsibility for current monetary policy and has been both blamed and credited — sometimes rightly so, and sometimes without justification — for the ups and downs of the post-crisis period.
It would be hard to find anyone willing to say that Bernanke has had a perfect track record, and the point here is not to idolize the chairman. There is certainly room for righteous criticism of current Fed policy, but there is also considerable evidence suggesting that without intervention from the central bank the slow recovery of the past few years — particularly in the equity markets — would have been even slower.
In the middle of May, Bloomberg published the results of a global poll of 906 decision makers in finance, markets, and economics. A majority of respondents (61 percent) indicated that they believed the U.S. economy was improving, whereas just 24 percent believed the global economy was improving. This view was supported by the fact that 57 percent of respondents believed that the U.S. Federal Reserve was doing the best job of handling the problems facing its economy. By and large, this indicates a high level of net approval for Bernanke’s policies, despite some justified criticism.
We take a look at the various reasons investors and economic leaders believe the Fed is navigating the post-crisis era better than anyone else.
1) Quantitative easing as a flow rate
Historically, QE programs involve purchases of a fixed amount of assets over a predetermined period of time. QE1, which lasted from November 2008 to March 2010, began as a program to purchase $500 billion in mortgage-backed securities, although total purchases expanded to $1.25 trillion. QE2 was an extension of QE that included the purchase of $600 billion of longer-term Treasury securities. Effectively, the Fed said that it was going to put a fixed amount of fuel into the economy, and see how far that would go.
This strategy clearly produced underwhelming results, and after a short round of stimulus, markets usually backtracked as the fuel ran out. With QE4, the most-recent iteration of the program, the Fed did not announce that it would be buying a predetermined amout of assets — or, injecting a fixed amount of fuel into the economy. “The difference with this program,” as Bernanke put it in a testimony before Congress, “is that we are buying a flow rate. We’re buying a certain amount of assets each month, and the amount that we purchase will depend on the data coming in.”
2) Forward guidance tied to economic indicators
The great challenge that has faced central bankers over the past few years (as they will be quick to point out) is what to do in a near-zero rate environment. Quantitative easing is one of several unconventional tools on the table, and forward guidance is another. Historically, in line with the tradition of purchasing a fixed amount of assets during a QE program, the extent of forward guidance offered by the Fed was usually confined to the total amount of purchases and a possible ending date. This creates a pessimistic signal problem (read more on this) that is damaging to markets and the economy.
In order to cope with this problem, the Fed adopted an unconventional policy and explicitly set a 2.5 percent inflation threshold and 6.5 percent unemployment target as the minimum criteria for a policy rate move. Combined with an explicit flow rate of QE purchases, the Fed has basically said that it will keep its foot on the gas until incoming data — specifically the unemployment rate — suggests that the economy has improved, and as long as inflation remains in check. This largely removes the pessimistic signal problem because the Fed is not pretending to know ahead of time when conditions will improve enough to warrant an end to the stimulus.
3) Recognition of monetary policy’s limitations
Chairman of the Joint Economic Committee Congressman Kevin Brady (R-Tex.) summed up the concerns of many Fed critics last week when he told Bernanke: “My worry is that the Fed doesn’t have the prescription for what ails our economy. A year ago, the Fed said that it wouldn’t set an employment target rate because it’s generally affected by non-monetary factors. But you’re unwinding the QE based on the employment areas that you have the least control of.”
Brady addresses a key concern of the post-crisis recovery, which is that monetary policy is primarily a tool that affects only short-term economic conditions. The unemployment rate has come down fairly steadily over the past few years, but as Bernanke articulated: “What we are trying to address here is the short-run cyclical gap… monetary policy can help to put people back to work in the short run.” What it can’t do is fix long-term unemployment or advance real net growth economic strategies.
4) Pointing a finger at Congress
What does affect long-term unemployment and what can advance real net economic growth strategies is fiscal policy, which is the guard of Congress. It is the job of state and federal policy makers to foster an environment that supports real long-term economic growth, where, as in the current situation, the best the Fed can do is add short-term fuel to the recovery.
As Bernanke pointed out to a congressional panel: “The expiration of the payroll tax cut, the enactment of tax increases, the effects of the budget caps on discretionary spending, the onset of the sequestration, and the declines in defense spending for overseas military operations are expected, collectively, to exert a substantial drag on the economy this year…The Congressional Budget Office estimates that the deficit reduction policies in current law will slow the pace of real GDP growth by about 1-1/2 percentage points during 2013, relative to what it would have been otherwise. In present circumstances, with short-term interest rates already close to zero, monetary policy does not have the capacity to fully offset an economic headwind of this magnitude.”
This is how the Dow Jones Industrial Average traded today:
Don’t Miss: Watch Out! Fed-Induced Bubbles Are Losing Time.