Friday, September 2, 2011

Reflections on Mr. Bernanke’s Speech at Jackson Hole and Future Monetary Policy

by Don Alexander, MBA

Associate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

Unlike at his Jackson Hole speech in 2010 when QE2 was presented, Fed Chairman Bernanke did not pull a rabbit out of the policy hat last week.  The focus was not on the immediate outlook for the economy or monetary policy, but more on the structural headwinds facing the US economy and other long-term issues such as fiscal policy.  Mr. Bernanke made two surprises on short-term policy: the lack of discussion about further asset purchases or other easing options and that further policy options will be considered at upcoming FOMC meetings.     

 

He differentiated between the cyclical and structural/secular role of monetary policy, noting that the Fed is less effective when it comes to the latter role.  He reminded his listeners that the Fed alone cannot carry such a heavy policy burden and that fiscal policy was needed to promote growth and stability.  Fiscal policymakers face a fine balancing act “the need to place fiscal policy on a sustainable path” and to avoid “severe economic and financial damage” while noting the fragility of the current environment.  He noted reforms are needed in other areas of economic management, emphasizing the need for a better process for making fiscal decisions.  

 

Mr. Bernanke noted economic policies that support robust economic growth in the long run are outside the province of the central bank.  He implied in the President’s upcoming speech on needed fiscal stimulus and job creation – a constructive and collaborative approach by the Administration and Congress was required.  Another round of damaging policy dithering and political bickering would have strong adverse consequences on the economy.

 

The Fed continues to have a more optimistic view on US economic prospects than most private sector analysts.  The major difference is the Fed assumes that a number of temporary factors that depressed economic activity in the first half will not be present in the second half.  If this view is correct, it would imply that chances for QE3 are minimal.  However, if the Fed view converges to that of private sector, the chances for QE3 increase.  The most likely form would be through increased asset purchases of longer-dated maturities.

 

Other extreme measures would not be considered, unless the economy and financial markets substantially deteriorate below current prospects.  The Fed would have three possible policy options: the extension of the QE program into other markets such as corporate bonds, a sharp increase in the program that extends the Fed’s balance sheet and an explicit or implicit change in the Fed’s policy targets.  However, US economic prospects have not deteriorated enough to consider these options.

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