The Federal Reserve has given the markets all it hoped for and more: unlimited quantitative easing (QE3), in the form of $40bn a month of mortgage bond purchases, an extension into 2015 of the zero-rate forecast, and a change in the reaction function to say the Fed won’t raise rates until an economic recovery is well under way.
Is this Ben Bernanke’s final shot? His own words suggest not. Here’s a handy checklist of what he’s done so far, and what could be to come, as set out in his 2002 speech on how to fight deflation. These are in the order he set them out in the speech, rather than the order in which they’ve been tried so far.
This started in August last year, when the Fed moved from expecting rates to remain low for an “extended period” to a prediction of rates staying on the floor until “mid 2013″. That has since been extended first to 2014, then 2015 – although it is worth noting the Fed has not actually committed to low rates (so far), only forecast them.
A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years). The Fed could enforce these interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields
No sign of this so far. The Fed fixed yields back in the 1940s, but ended in 1951 and hasn’t explicitly capped yields since then.
Yet another option would be for the Fed to use its existing authority to operate in the markets for agency debt (for example, mortgage-backed securities issued by Ginnie Mae, the Government National Mortgage Association)
This was part of the Fed’s first foray into alternative monetary policy, with QE1 purchases of agency debt and mortgage bonds. It is also the basis for QE3
If lowering yields on longer-dated Treasury securities proved insufficient to restart spending, however, the Fed might next consider attempting to influence directly the yields on privately issued securities
The Bank of Japan has tried this, buying commercial paper, corporate bonds, and now spending Y1.6tn ($20bn) on equity index ETFs and another Y120bn on REITs, property holding companies. The Fed would need a change to the law to allow it to venture into these securities.
A second policy option, complementary to operating in the markets for Treasury and agency debt, would be for the Fed to offer fixed-term loans to banks at low or zero interest, with a wide range of private assets (including, among others, corporate bonds, commercial paper, bank loans, and mortgages) deemed eligible as collateral
This was part of QE1, when the Term Asset-backed Loan Facility (TALF) was created to lend money to banks secured on ABS, bonds backed by such things as credit card loans and mortgages.
After this Mr Bernanke started to get into the extreme options, so far not tried – or at least not directly.
…since the United States is a large, relatively closed economy, manipulating the exchange value of the dollar would not be a particularly desirable way to fight domestic deflation, particularly given the range of other options available. Thus, I want to be absolutely clear that I am today neither forecasting nor recommending any attempt by U.S. policymakers to target the international value of the dollar.
One caveat: while the Fed has not directly bought foreign debt (a method used by central banks such as the Bank of Japan, People’s Bank of China or Swiss National Bank to weaken their currencies), it has engaged in international swaps to lend dollars to foreign central banks at times of crisis. This is not the same, and indeed this measure may have been critical in averting an emerging market debt and currency crisis in October 2008. However, by increasing the supply of dollars it does weaken the currency – or at the least mitigate the rise in the dollar the international dollar shortage would otherwise have led to.
A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices. Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers. A money-financed tax cut is essentially equivalent to Milton Friedman’s famous “helicopter drop” of money
This is why Mr Bernanke is known as “Helicopter Ben”. The Fed has not helped the government try a Fed-financed tax cut. On the other hand, the US government has run an unprecedented peacetime deficit, including lots of tax cuts in the Obama stimulus plan and subsequent extension of the Bush tax cuts. The Fed’s QE purchases of Treasury bonds have helped to finance it by keeping rates down – but this was not the stated intention, which would be a much bigger step.
To sum up: the Fed has certainly not yet reached the limit of its firepower. But it is already pushing the boundary of what is politically acceptable, with Mitt Romney quickly attacking yesterday’s QE3 and promising to replace Mr Bernanke if the Republicans win the White House in November. Any attempt to widen its mandate to allow it to buy equities looks sure to be rejected by Congress, while it would be a brave Fed which used American dollars to buy foreign government bonds.
For those worried that the Fed is debasing the dollar by printing unlimited money, take heart. Back in 2002, at least, Mr Bernanke was able to reassure everyone that “the U.S. government is not going to print money and distribute it willy-nilly”.