We’ve said a few times that there are right ways and wrong ways to criticise QE2. One of the wrong ways, it seems to us, is to say that the policy hasn’t had its intended affect on markets.
The goal of quantitative easing at the zero lower bound isn’t to lower nominal treasury yields (though that’s not a surprising immediate effect) but to lower expected real yields by raising inflation expectations.
As St Louis Fed president James Bullard explained last Thursday, so far so good. Since Bernanke gave his Jackson Hole speech telegraphing further QE, real interest rates are lower, inflation expectations and US equities are higher, and the dollar has broadly depreciated against other currencies.
Or if you want to look at it another way, at the very least the expected probability of deflation is lower than it was earlier this year — as you can see in this new chart from Macroblog:
Fed chairman Ben Bernanke is taking his QE2 outreach on the road to Columbus, Ohio, tomorrow for a ‘conversation on the economy’ with business leaders. It’s supposed to focus on the job market but I imagine it will turn to monetary policy. Businesspeople scheduled to attend include:
Alan Mulally, President and CEO, Ford Motor Company, Dearborn, MI
Samuel Palmisano, Chairman of the Board and CEO, IBM Corporation, Armonk, NY
Curtis Moody, President and CEO, Moody•Nolan, Inc., Columbus, OH
Jeni Britton Bauer, President, Jeni’s Splendid Ice Creams, Columbus, OH
Dwight Smith, CEO, Sophisticated Systems, Columbus, OH
Blink and you may have missed it.
But last Friday, Ben Bernanke probably made his most important speech since his ‘helicopter money‘ talk almost eight years ago.
According to author and economist Richard Duncan this is the first time the Federal Reserve chairman has publicly pointed out that the international monetary system may have a structural flaw. In the dollar standard.
As Duncan told FT Alphaville this weekend:
In it he conceded the Dollar Standard is flawed. He said, “As currently constituted, the international monetary system has a structural flaw: It lacks a mechanism, market based or otherwise, to induce needed adjustments by surplus countries, which can result in persistent imbalances.”
Officials from Taiwan’s central bank have rejected the implication of currency undervaluation in a chart used by Ben Bernanke. The offending graph – to the right – shows changes in the real effective exchange rate on its vertical (y) axis. Taiwan’s currency weakened by 2.8 per cent in real terms between September 2009 and 2010, according to this Fed chart. Taiwan says it fell by just 0.2 per cent, and argues that REER is not a good measure of undervaluation anyway.
At stake is responsibility for volatile capital flows that add to inflation in emerging markets and threaten to destabilise recovery. Emerging markets point to the Fed’s stimulus programme. But Mr Bernanke argued in his speech that the Fed’s $600bn stimulus programme was good for the world economy, refusing to accept responsibility for the extra inflationary pressure flowing through to emerging markets. In spite of former chair Alan Greenspan’s comments to the contrary, the Fed also continues to deny any attempt deliberately to weaken the dollar.
Indeed, Mr Bernanke accused emerging market economies of spending their reserves to slow the appreciation of their currencies. Hot money, he argued, was flowing into emerging markets regardless of Fed actions, because investors expected currencies they were buying to strengthen further. Since – by this chart – Taiwan’s currency has strengthened the least (indeed, has weakened), the implication is that Taiwan is one of the worst ‘offenders’.
Ben Bernanke, the US Federal Reserve chairman, was forthright when he spoke at a European Central Bank conference in Frankfurt this morning. As reported on ft.com, he defended the Fed’s latest quantitative easing measures, and sought to turn the fire instead on China.
As I predicted in a previous post, Jean-Claude Trichet, ECB president, avoided any great clash with his US counterpart, whom he described as “a great member of the brotherhood of central bankers”. Others at the ECB may worry about further dollar weakness. But the ECB president repeated how US authorities also saw a strong dollar as important. On Mr Bernanke’s broader points about tackling global imbalances, Mr Trichet was also supportive.
But Mr Trichet seemed unnecessarily defensive of the eurozone at times. He interjected at one point that Europe’s monetary union was broadly in balance, even if some countries (Germany) had large surpluses. As far as I could tell, Mr Bernanke was not referring to Germany in this context at all.
China and other developing countries should act to reduce their current account surpluses, US Federal Reserve chairman Ben Bernanke said in a firm rebuff to complaints that the Fed is manipulating the dollar.
“The current international monetary system is not working as well as it should,” Mr Bernanke said in a speech delivered at a European Central Bank conference on Friday morning. “Currency undervaluation by surplus countries is inhibiting needed international adjustment and creating spillover effects that would not exist if exchange rates better reflected market fundamentals.”
If he were still alive today, what would Milton Friedman think of his disciple, Ben Bernanke? This is a matter of some concern to the Fed chairman, who is reported as saying to colleagues on Saturday: “I grasp the mantle of Milton Friedman…I think we are doing everything (he) would have us do.”
With libertarian economists tending to be among those most critical of QE2, Mr Bernanke is relying on Friedman’s halo effect to enhance the legitimacy of the Fed’s recent actions. Friedman’s friends say that his opinions were unpredictable, which is what made them interesting. But some some free market economists, like Allan Meltzer, claim that Friedman would have strongly disapproved of QE2. Are they right?
Mr Bernanke’s admiration for Milton Friedman goes a long way back. In this famous speech, made in honour of Friedman’s 90th birthday in 2002, Mr Bernanke described his hero in simple but glowing language:
“Among economic scholars, Friedman has no peer.”
Fed chairman Ben Bernanke has an op-ed in the Washington Post. He argues that QE2 will be effective:
This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate this additional action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.
He takes on critics who fear inflation:
One of the main things I took from chairman Bernanke’s speech last Friday was a wish to refocus attention on the Fed as an inflation-targeting central bank.
Although attaining the long-run sustainable rate of unemployment and achieving the mandate-consistent rate of inflation are both key objectives of monetary policy, the two objectives are somewhat different in nature.
Most importantly, whereas monetary policymakers clearly have the ability to determine the inflation rate in the long run, they have little or no control over the longer-run sustainable unemployment rate, which is primarily determined by demographic and structural factors, not by monetary policy. Thus, while central bankers can choose the value of inflation they wish to target, the sustainable unemployment rate can only be estimated, and is subject to substantial uncertainty.
Moreover, the sustainable rate of unemployment typically evolves over time as its fundamental determinants change, whereas keeping inflation expectations firmly anchored generally implies that the inflation objective should remain constant unless there are compelling technical reasons for changing it, such as changes in the methods used to measure inflation.
I think this highlights the enormous problems caused by targeting inflation without being willing to be admit that you have an inflation target. The Fed fondly imagines that the world understands it is targeting inflation. It is not a surprise it believes this: it talks to economists who run models in which it has a 2 per cent inflation target and to hacks like me who are misspending our lives studying Fed-speak.