Friday, August 27, 2010

Analysis: Bernanke paves the way for QE2

by Bill McBride on 8/27/2010 11:22:00 AM

Just some quick thoughts on Fed Chairman Ben Bernanke's speech today.

  • Bernanke has a political problem on the FOMC. I believe this is why the recent FOMC discusssions were leaked to Jon Hilsenrath at the WSJ: Fed Split on Move to Bolster Sluggish Economy

  • Bernanke is saying the economy is weak but that he still expects growth to improve in 2011:
    For a sustained expansion to take hold, growth in private final demand--notably, consumer spending and business fixed investment--must ultimately take the lead. On the whole, in the United States, that critical handoff appears to be under way. ... the pace of that growth recently appears somewhat less vigorous than we expected. ... Incoming data on the labor market have remained disappointing. ... Overall, the incoming data suggest that the recovery of output and employment in the United States has slowed in recent months, to a pace somewhat weaker than most FOMC participants projected earlier this year. ... I expect the economy to continue to expand in the second half of this year, albeit at a relatively modest pace.

    Despite the weaker data seen recently, the preconditions for a pickup in growth in 2011 appear to remain in place.
  • So it will take further disinflation or a weaker economy for the Fed to act. Bernanke discussed the when of QE2:
    Under what conditions would the FOMC make further use of these or related policy tools? At this juncture, the Committee has not agreed on specific criteria or triggers for further action, but I can make two general observations.

    First, the FOMC will strongly resist deviations from price stability in the downward direction. ... It is worthwhile to note that, if deflation risks were to increase, the benefit-cost tradeoffs of some of our policy tools could become significantly more favorable.

    Second, regardless of the risks of deflation, the FOMC will do all that it can to ensure continuation of the economic recovery. Consistent with our mandate, the Federal Reserve is committed to promoting growth in employment and reducing resource slack more generally. Because a further significant weakening in the economic outlook would likely be associated with further disinflation, in the current environment there is little or no potential conflict between the goals of supporting growth and employment and of maintaining price stability.
  • And Bernanke made his preference clear for QE2:
    A first option for providing additional monetary accommodation, if necessary, is to expand the Federal Reserve's holdings of longer-term securities. As I noted earlier, the evidence suggests that the Fed's earlier program of purchases was effective in bringing down term premiums and lowering the costs of borrowing in a number of private credit markets. I regard the program (which was significantly expanded in March 2009) as having made an important contribution to the economic stabilization and recovery that began in the spring of 2009. Likewise, the FOMC's recent decision to stabilize the Federal Reserve's securities holdings should promote financial conditions supportive of recovery.

    I believe that additional purchases of longer-term securities, should the FOMC choose to undertake them, would be effective in further easing financial conditions.
    Bernanke was not as positive on changes to the "extended period" language or reducing the interest rate on excess reserves.

  • Summary: I think Bernanke is paving the way for QE2, although he probably feels he needs more evidence of a slowing economy or further disinflation to persuade other members of the FOMC. A warning from a large tech company is probably significant at this point, like from MarketWatch: Intel cuts sales forecast citing weaker consumer PC market
    "Revenue is being affected by weaker than expected demand for consumer PCs in mature markets," the company said in a statement.
    Or perhaps the unemployment rate ticking up in the August employment report next Friday might be enough. There will be plenty of data released before the September 21 FOMC meeting (and if the data is weaker, the meeting might be expanded to two days). Or perhaps the FOMC will wait until November, but it does appears Bernanke is preparing everyone for QE2.

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