The Fed’s Remaining Tools That Could Boost The Economy

Even though most of its heavy arsenal already depleted, the Federal Reserve still has some bullets left. As the Fed moves into uncharted territory, though, there is some …

Even though most of its heavy arsenal already depleted, the Federal Reserve still has some bullets left. As the Fed moves into uncharted territory, though, there is some unease as to whether it has enough firepower. See the following article from HousingWire for more on this.

Federal Reserve Chairman Ben Bernarke said in a speech this morning that the Fed still has several “tools and strategies for providing additional stimulus.”

The words are a strong indicator that more economic support is due by the Fed and to perhaps serve as a counterargument to recent claims that the US government is running out of bullets in its gunfight against a flagging economy.

Speaking at the Federal Reserve Bank of Kansas City’s annual economic symposium in Jackson Hole, Wyo., Bernake said that the zero interest rate policy (ZIRP) is unlikely to change in the coming months. He also doesn’t see any short-term risk of deflation. However, federal economic stimulus can only drive recovery temporarily. For a sustained expansion to take hold, growth in consumer spending and business fixed investment needs to come more into focus, he said.

“Notwithstanding the fact that the policy rate is near its zero lower bound, the Federal Reserve retains a number of tools and strategies for providing additional stimulus,” Bernake said.

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“I will focus here on three that have been part of recent staff analyses and discussion at Federal Open Market Committee (FOMC) meetings: conducting additional purchases of longer-term securities, modifying the committee’s communication, and reducing the interest paid on excess reserves. I will also comment on a fourth strategy, proposed by several economists–namely, that the FOMC increase its inflation goals.”

Bernanke added that Fed strategy relies on the presumption that different financial assets aren’t perfect substitutes in investors’ portfolios, so changes in the net supply of an asset available to investors affect its yield and those of broadly similar assets.

In the same speech last year, Bernanke was more bearish, instead choosing to focus on how federal government interventions lessened the blow of the recession, despite irresponsible activity in the private financial sector. There seems to be less finger wagging this time around, and more fist pounding.

“Our purchases of Treasury, agency debt, and agency MBS likely both reduced the yields on those securities and also pushed investors into holding other assets with similar characteristics, such as credit risk and duration,” Bernanke said Friday. “For example, some investors who sold MBS to the Fed may have replaced them in their portfolios with longer-term, high-quality corporate bonds, depressing the yields on those assets as well.”

Bernanke said that reinvestment in Treasury securities is more consistent with the FOMC’s longer-term objective of a portfolio made up principally of Treasury securities. “We do not rule out changing the reinvestment strategy if circumstances warrant, however,” he added.

“By agreeing to keep constant the size of the Federal Reserve’s securities portfolio, the committee avoided an undesirable passive tightening of policy that might otherwise have occurred,” he said. “The decision also underscored the committee’s intent to maintain accommodative financial conditions as needed to support the recovery. We will continue to monitor economic developments closely and to evaluate whether additional monetary easing would be beneficial.”

The annual speech is seen as an indicator of the Fed’s activity for the coming year and every word is scrutinized by economists. Already the reaction is somewhat incredulous: “Changing the language on the near-zero short-rate commitment is still a possibility but, again, do we really think that driving the longer end of the yield curve down a bit is going to save the economy?” asked Paul Ashworth, senior US economist at Capital Economics.

“In sum, don’t expect any Fed action soon. If economic conditions get a lot worse, the Fed would announce a new program of Treasury bill/bond purchases and probably put more weight on explicit monetary targets, in the same way the Japanese did, Ashworth said, adding that such an option would have a limited impact on the economy.

This article has been republished from HousingWire. You can also view this article at
HousingWire, a mortgage and real estate news site.


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