Ben Bernanke is now officially a lame duck. His successor has been nominated and has aced her confirmation hearing. His own mind has surely drifted to the days ahead on the beach or wherever he plans to go come February, when the weight of the world economy is removed from his shoulders.
But a speech he gave Tuesday night in Washington is important despite that lame duck status. It is important not merely because Bernanke is the Federal Reserve's chairman for another two months and some change, but because he takes his responsibility to speak for the whole Fed policy committee seriously. And it's a given that he wouldn’t suggest anything about the future course of policy without a sense that such a path was the consensus of the Fed policy committee and, in particular, a direction that his designated successor, Janet Yellen, will be comfortable with.
But what was the message?
To oversimplify: Quantitative easing maybe isn’t all that great, after all. But sending signals about our future interest rate policy is. So, just because QE may end soon, doesn't mean you should doubt the Fed's resolve to get the economy back on track.
There has been a long debate over how Fed policies affect the economy when interest rates are near zero. One school of thought emphasizes how the Fed can use newly created money to buy bonds to directly affect markets: When the Fed buys Treasury bonds and mortgage-backed securities, others who would have bought those securities have to buy something else, which pushes down all kinds of long-term borrowing rates across the economy and pushes the stock market and other assets up.
A second school of thought holds that what’s really important is expectations. Do investors believe that the Fed will have the resolve to do whatever necessary to get inflation back up to its 2 percent target and bring unemployment down? Or will the central bank pull away the punch bowl of easy money before the party can really get started?
Even for adherents of this thinking, QE policies can help, because they are a concrete signal of the central bank’s resolve. Talk is cheap; a $3 trillion bond portfolio isn’t.
The experience of the last few years — during which Fed bond-buying policies haven’t led to robust growth — has made the second theory look better and better.
And Bernanke essentially affirmed that this is the current state of Fed thinking with his comments Tuesday night before the National Economists Club. The central bank is trying to pivot away from buying bonds and toward using guidance about its future plans as a policy tool. Now Bernanke, and soon Yellen, just need to persuade Wall Street that winding down QE doesn’t mean they are any less committed to returning the economy to its pre-crisis growth path.
Bernanke said in his speech that after the Fed signaled in June that it would soon taper its bond-buying program, “market participants may have taken the communication in June as indicating a general lessening of the Committee's commitment to maintain a highly accommodative stance of policy in pursuit of its objectives. . . .To the extent that this . . . factor--a perceived reduction in the Fed's commitment to meeting its objectives--contributed to the increase in yields, it was neither welcome nor warranted, in the judgment of the FOMC. This change in expectations did not correspond to any actual lessening in the FOMC's commitment or intention to provide the high degree of monetary accommodation needed to meet its objectives.”
Bernanke, echoing several of his Fed colleagues, is trying to signal loudly and clearly that markets shouldn’t start pricing in higher interest rates just because the central bank tapers and then ends its QE policies.
Even as Bernanke signaled that a wind-down of bond-buying isn’t far away, he doubled up affirming the Fed’s resolve to get the economy back on track, specifically by saying that “even after unemployment drops below 6-1/2 percent, and so long as inflation remains well behaved, the Committee can be patient in seeking assurance that the labor market is sufficiently strong before considering any increase in its target for the federal funds rate.”
Got that: We’re not going to run for the exits the minute unemployment falls to 6.5 percent. In all likelihood, we will keep our pedal on the gas. Honest. He left unsaid the fact that he won't be around for all of this, but it is highly unlikely he would have made such comments about the future course of policy without Yellen's agreement.
Bernanke is trying to leave his successor an easier job. Many of members of the Fed policy committee are wary of the effect that a soon-to-be $4 trillion balance sheet may have on a range of markets, contributing to asset bubbles, disrupting markets that depend on increasingly scarce Treasury bonds as collateral, and setting the stage for a long, difficult process of unwinding things when the time comes.
If Bernanke’s effort is successful, Yellen will take office with the tools to keep strong Fed support for growth in place, without some of the nasty side effects of bond-buying.
The $1 trillion question is whether the dual message — that QE could soon end but that easy money is here to stay — is one that markets will believe.