The much awaited speech by Ben Bernanke at Jackson Hole was largely a holding operation. He did not deviate much, if at all, from the tone of the statement issued after the August meeting of the FOMC, which is understandable given that his policy committee contains several members who do not want the Fed chairman to offer any strong hints about further policy easing at this stage. More evidence of a weakening US economy, and much more discussion within the committee, will be needed before this can happen.
Mr Bernanke’s description of the current and future prospects for the economy was a little more up-beat than the current consensus of opinion among market economists, and more optimistic than my own assessment. Picking over the details of what he said, he suggested that GDP growth would be moderate in the remainder of 2010, and would rise next year, with unemployment and capacity utilisation falling slightly in 2011. This implies that he expects GDP growth in 2011 to be somewhere around 2.5 per cent, just fractionally above the long term trend; and that in turn might imply a growth rate of around 1.5 to 2 per cent in the second half of 2010. This would be roughly the same as the GDP growth rate in Q2, which has just been revised downwards to 1.6 per cent.
Importantly, there was no hint that the Fed expects a double dip in the economy, and there was an explicit statement to the effect that the risks of falling into deflation are very low. However, the chairman said that the inflation rate was already a little below the rate which the Fed considers optimal, and he gave a fairly clear commitment that the FOMC would “certainly use its tools as needed to maintain price stability – avoiding excessive inflation or further disinflation.” The last two words might be read as slightly dovish, since he clearly wants to avoid any further drop in core inflation from its current 1 per cent rate, and therefore will not wait until there is a serious threat of outright deflation (falling prices) before taking further action.
On quantitative or other forms of unconventional monetary easing, the chairman once again said very confidently that, even though short rates are almost at zero, the Fed still had several instruments available which could effectively support the economy if needed. He said that the Fed was ready to use one or more of these tools, “especially if the outlook were to deteriorate significantly”. The word “especially” (repeated twice) is quite interesting in this context, since it implies that further action could conceivably be taken even if the outlook did not deteriorate significantly, which is also a bit dovish.
On the measures which the Fed might use, Mr Bernanke ruled out any increase in the inflation target (which is a relief), and he suggested (realistically) that a small cut in the interest rate paid by the Fed on bank reserves would only have minimal effects, because the rate was already as low as 0.25 per cent. He seemed open minded on the other two options – which are to purchase long term securities, thereby expanding QE, or to offer a commitment that the Fed would maintain exceptionally low short term interest rates for an even longer period than currently expected. However, his tone suggested that asset purchases might be more effective and less complicated than the communication option, which certainly seems to be the right judgment.
This speech will disappoint those who believe the economy is urgently in need of further QE. Goldman Sachs says he is “watching and waiting”, despite the fact that the economy is growing below potential. However, given the risks that more QE would involve (see this previous blog), this is surely what you would expect from a risk averse Fed chairman. He is certainly no hawk, and will take further action if inflation drops any further. That is, he will if his colleagues on the FOMC let him.
