Fed Chairman Ben Bernanke: There would appear to be a case for further action
15.10.10 19:54

The chairman's comments at the Federal Reserve Bank of Boston this morning were largely in line with our expectations. He laid out a case for a recovery being in place, but that the slow progress appeared to provide a need for further action. He believes that cyclical factors are behind the high level of unemployment and reiterated the Fed's long-term inflation mandate as consistent with a target of about 2% inflation (or slightly below).

Regarding policy options, he continues to favor asset purchases, although he also notes the potential risks associated with a significant expansion of the Fed's balance sheet. He also appears to remain open to alternative communication strategies that may strengthen the "extended period" language. His comments tell us that the chairman likely favors further action at the upcoming November FOMC meeting, but that the Fed should proceed with caution and seek ways to pair communication with asset purchases to help monetary policy achieve its dual mandate of stable inflation and high employment. We continue to expect the Fed to initiate a new round of asset purchases in November, and see the committee as adopting an incremental approach to purchases.

On the outlook for growth and inflation, the chairman stated that the hand-off from the inventory-led rebound to a sustained expansion driven by growth in final demand is underway, but growth has been proceeding at a pace "that is less vigorous than we would like." Regarding the high level of unemployment, the chairman said that he sees nothing that leads him to believe the structural unemployment factors are different from previous recessionary periods, judging that the "bulk of the increase in unemployment" is attributable to the downturn in activity. His comments here on the nature of unemployment were more forceful than we have heard from him in the past and are a clear indication that he believes monetary policy can be effective in reducing unemployment, albeit slowly, by stimulating aggregate demand. This would put him more in line with Rosengren, Yellen, and Dudley, who have made similar comments, and in contrast with other FOMC members who see structural factors as inhibiting the ability of policy to reduce unemployment.

On the inflation front, the chairman's comments were in line with our expectations. He stopped well short of advocating aiming at above-target inflation, a price level target, or nominal GDP targeting; in fact, these were not even mentioned in the speech. Instead, he reiterated that he interprets the Fed's inflation mandate as meaning targeting a "modestly positive inflation rate over the longer run" and that the longer-run inflation forecasts provided by FOMC participants reveal the "mandate-consistent inflation rate" to be "about 2% inflation or below" (original emphasis). As an aside, the use of "mandate-consistent" when describing the inflation objective is about as close as a Fed chairman can come to announcing an inflation target. Beyond this, there was nothing in the speech to indicate that the chairman seeks anything other than to have monetary policy effectively anchor long-term inflation expectations at this level. In this regard, he was fairly straightforward in saying that "inflation is running at rates that are too low relative to the levels that the committee judges to be most consistent with the Federal Reserve's dual mandate in the longer run" (original emphasis) and that "the risk of deflation is higher than desirable." This, in line with his comments on unemployment being cyclical versus structural, is a clear signal that he would favor further stimulus.

If there was further news in the speech, it came during his discussion on the available policy tools the Fed could use. In contrast to his speech at Jackson Hole, the chairman said nothing about potentially reducing the interest rate on excess reserves. Instead, he focused on the risk-reward trade-off on asset purchases and discussed how communication strategies could "presumably lower longer-term rates by an amount related to the revision in policy expectations." This tells us that the chairman would be open to ways that the FOMC might pair asset purchases with some strengthening of the "extended period" language. While we still see some drawbacks to this, given the communication problems it may create, it is nevertheless instructive of his thinking. We think the chairman views the risks of further asset purchases as real and that he would be open to pairing purchases with other communication measures that could anchor policy expectations and lower interest rates across the yield curve more than purchases of longer-term Treasuries alone could achieve. This could be achieved by linking the "extended period" language to economic conditions and the dual mandate. In short, we read the chairman's comments as reducing the probability of dovish inflation options, while seeking to have the committee proceed with caution on asset purchases and consider alternative communication strategies.



Michael Gapen wrote in a Barclays Capital Research report.
 
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