There was a huge amount of media and market hype ahead of Bernanke’s speech at Jackson Hole on Friday. The media and many market participants assumed that Bernanke would at least announce QE3 – I am not sure why? The last FOMC meeting was as recent as 9 August, which would have afforded the Fed an opportunity to introduce QE3 had they thought it was appropriate. Instead the Fed opted to peg the benchmark Federal Funds Target Rate at between 0.0% and 0.25% to mid-2013 - with three dissenting votes, which also would have made QE3 far less likely.
As it transpired Bernanke delivered a fairly low key speech and did not add much to the near-term policy debate. He highlighted that the Fed has a “range of tools” (such as?) and that an extended FOMC meeting in September (extended from a one day meeting to a two day meeting) would be full of discussion of the relative merits of using these tools.
The second half of Bernanke’s speech focused on the longer run, where the Chairman noted that “my own view is more optimistic… the growth fundamentals of the US do not seem to have been permanently altered by the shocks of the past four years.” There is merit in the argument that had the Fed introduced QE3 it would have sent a very negative message about the state of the US economy, without necessarily providing much additional stimulus. In fact, Bernanke made the point in his speech that the recent dip in commodity prices (which would probably have been partially reversed by QE3) should start to help consumer activity.
There was probably not enough discussion in the speech about the current failure of the US monetary transmission mechanism to deliver a better outcome, in particular, the poor state of the home mortgage lending market. The US is increasingly being referred to as the homeless recovery. Although to be fair to Bernanke, there are now an extreme number of armchair economists weighing in on the debate.
The following is a summary of the key points in Bernanke’s Jackson Hole, 2011, speech:
Positive developments:
- The global economy has seen significant growth, led by the emerging-market economies.
- In the US, a cyclical recovery, though a modest one by historical standards, is in its ninth quarter.
- Although important problems certainly exist, the growth fundamentals of the United States do not appear to have been permanently altered by the shocks of the past four years.
- In the financial sphere, the US banking system is generally much healthier now, with banks holding substantially more capital. Credit availability from banks has improved.
- Companies with access to the public bond markets have had no difficulty obtaining credit on favorable terms.
- Structural reform is moving forward in the financial sector.
- Manufacturing production in the United States has risen nearly 15 percent since its trough, driven substantially by growth in exports.
- Business investment in equipment and software has continued to expand, and productivity gains in some industries have been impressive.
- Households also have made some progress in repairing their balance sheets - saving more, borrowing less, and reducing their burdens of interest payments and debt.
- Commodity prices have come off their highs, which will reduce the cost pressures facing businesses and help increase household purchasing power.
Concerns:
- The recovery from the crisis has been much less robust than the Fed had hoped.
- The recession was even deeper and the recovery even weaker than the Fed had thought. Aggregate output in the United States has still has not returned to the level that prevailed before the crisis.
- Economic growth has been at rates insufficient to achieve sustained reductions in unemployment.
- Temporary factors, including high commodity prices and the effect of the Japanese disaster, were part of the reason for the weak performance of the economy in the first half of 2011. Growth in the second half looks likely to improve as their influences recede.
- The recession was unusual in being associated with both a very deep slump in the housing market and a historic financial crisis.
- The weakness of the housing sector has had adverse effects on financial markets and on the flow of credit.
Housing market:
- The housing sector has been a significant driver of recovery from most recessions in the United States since World War II.
- With an overhang of distressed and foreclosed properties as well as tight credit conditions, the rate of new home construction has remained at less than one-third of its pre-crisis level.
- The low level of construction has implications not only for builders but for providers of a wide range of goods and services related to housing and homebuilding.
Monetary policy:
- The recent data has indicated that economic growth during the first half of this year was considerably slower than the FOMC had been expecting.
- Temporary factors can account for only a portion of the economic weakness.
- Although the Fed expects a moderate recovery to continue and to strengthen over time, the Fed has revised down its growth outlook.
- The Fed has a range of tools that could be used to provide additional monetary stimulus. The Fed discussed the relative merits and costs of such tools at their August meeting and will discuss policy options further at their meeting in September.
Fiscal policy:
- Although the issue of fiscal sustainability must urgently be addressed, fiscal policymakers should not, as a consequence, disregard the fragility of the current economic recovery.
- Need to put in place a credible plan for reducing future deficits over the longer term, while being attentive to the implications of fiscal choices for the recovery in the near term.
- Fiscal policymakers can also promote stronger economic performance through the design of tax policies and spending programs.
- The country would be well served by a better process for making fiscal decisions. The negotiations that took place over the summer (debt ceiling debacle) disrupted financial markets and probably the economy as well.
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