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Federal Reserve Chairman Ben S. Bernanke says the U.S. economy is “far from satisfactory.” His colleagues are moving to embrace policies that will stay in place until he’s satisfied.
Four Fed presidents have come out in favor of an open-ended strategy for bond buying, with three calling for the program to begin now. Rather than specify a fixed amount of bonds to purchase by a certain date, such a strategy would leave the Fed able to announce a pace of purchases that it could adjust as the economy gets closer to Bernanke’s goals.
“You would be able to react to the incoming data in an incremental way and not be in a situation where you have to either drop the bomb or do nothing,” St. Louis Fed President James Bullard said in an interview last week during the Fed’s annual monetary policy symposium in Jackson Hole, Wyoming.
Bernanke used the forum to defend unorthodox policies such as bond purchases and made the case for further action to reduce an unemployment rate that he called a “grave concern.” Stocks and Treasuries jumped after the speech as investors increased bets the Fed will opt for further easing as soon as its next meeting Sept. 12-13.
“It is important to achieve further progress, particularly in the labor market,” Bernanke said last week. San Francisco Fed President John Williams, Chicago’s Charles Evans and Boston’s Eric Rosengren have joined Bullard in endorsing open- ended bond-buying to push down an unemployment rate stuck above 8 percent for 42 consecutive months.
Flow of Purchases
“That might take the form of announcing a flow of purchases of securities per month” that would continue “for as long as appropriate,” Williams said in an interview at Jackson Hole. The Fed would then “adjust this program as time goes on, either to increase it or decrease it, end it sooner or later, depending on how economic conditions develop.”
“There has been more talk among members of the FOMC of an open-ended program,” Dean Maki, chief U.S. economist at Barclays Plc, said in an interview at Jackson Hole. Such a program would be more effective because it “would emphasize the unlimited nature of the Fed’s balance sheet and that they’re willing to do as much as necessary.”
The minutes of the Federal Open Market Committee’s July 31- Aug. 1 meeting showed that many policy makers said a new bond- buying program should “be sufficiently flexible to allow adjustments, as needed, in response to economic developments or to changes in the committee’s assessment of the efficacy and costs of the program.”
Williams said the purchases could consist of both Treasuries and mortgage-backed securities. He said the appropriate program may need to wind up being “at least as large as QE2 or arguably even larger again.”
The Fed bought a total of $2.3 trillion of securities from 2008 through June 2011. The first round of so-called quantitative easing consisted of mortgage-backed securities, federal agency debt and Treasuries, while the second round was limited to $600 billion of Treasuries.
The Fed is also considering a strategy of emphasizing economic conditions as it explains how long it’s likely to hold its target interest rate near zero, as it has done since December 2008. The FOMC has said since January that it expects economic conditions to warrant keeping the rate “exceptionally low” until at least late 2014.
A few participants at the FOMC’s most recent meeting suggested “replacing the calendar date with guidance that was linked more directly to the economic factors that the committee would consider in deciding to raise its target for the federal funds rate, or omit the forward guidance language entirely.”
Such a strategy came up for discussion in Jackson Hole, when Columbia University Professor Michael Woodford presented a paper in front of Bernanke and a group of about 120 central bankers, academics and journalists. In it, he argued that the Fed’s current communications strategy may be counterproductive.
Pledging to hold interest rates lower for longer could “reflect pessimism about the speed of the economy’s recovery,” Woodford wrote. “A more useful form of forward guidance, I believe, would be one that emphasizes the target criterion that will be used to determine when it is appropriate to raise the federal funds rate target above its current level, rather than estimates of the ‘lift-off’ date.”
The Chicago Fed’s Evans, who does not vote on monetary policy this year, has favored making both bond purchases and the benchmark interest rate contingent on a better labor-market outlook.
The strategy for more bond-buying “could be open-ended purchases, meaning that they would continue at a certain rate until there was clear evidence of improvement in economic conditions,” Evans said in an Aug. 27 speech in Hong Kong. “To me, one example of clear evidence would be a resumption of relatively steady monthly declines in unemployment for two or three quarters.”
Evans has also argued that the Fed should hold interest rates near zero until the jobless rate falls below 7 percent, so long as inflation does not breach 3 percent.
The unemployment rate probably held at 8.3 percent in August, according to the median forecast of economists surveyed by Bloomberg News ahead of Labor Department figures Sept. 7. Payrolls may have grown by 125,000 following a gain of 163,000 in July.
Joseph LaVorgna, chief U.S. economist for Deutsche Bank Securities Inc. in New York, said the Fed may be unable to reach consensus on such strategies. LaVorgna said his baseline forecast doesn’t include more asset purchases in any form because the economy isn’t at risk of deflation.
Unable to Agree
While it would “make more sense for the Fed to say we’re not going to raise rates until we get a certain set of economic conditions,” policy makers may be unable to agree on terms, LaVorgna said. “The problem you have is very different scenarios. Unemployment could come down more slowly while inflation picks up more quickly or vice-versa.”
The debate has international resonance. Adam Posen, whose three-year term as a policy maker at the Bank of England ended last week, said setting thresholds acknowledges economies are in a special set of circumstances and gives the public something they can understand and monitor.
He once studied a commitment from the Bank of Japan not to raise interest rates before inflation rose above zero and found it “seemed to have a meaningful impact on long rates.”
“Talking is good, but it’s got to be action-oriented talking,” he said. “Better to say and do than to just say.”
Still, Deputy Bank of England Governor Charles Bean told the conference that changes in the membership of policy-setting committees undermine the ability to give strong commitments about future decisions.
Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey, said the Fed’s statement at the conclusion of next week’s meeting may take a step in better describing what economic conditions would prompt the Fed to begin raising interest rates.
The minutes suggested that the committee could signal it would keep rates low “even as the recovery progressed,” Crandall said.
“They are likely to have a very strong preference of having a way to bolster that guidance without taking the brute force solution of extending it even farther into a nebulous future,” Crandall said.
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