Friday, November 19, 2010

Bernanke's gambit

The Full Statement Can Be Found Here.

My comments in italics where appropriate, this is an abridged version of the full statement.

The Federal Reserve's policy target for the federal funds rate has been near zero since December 2008, so another means of providing monetary accommodation has been necessary since that time. Accordingly, the FOMC purchased Treasury and agency-backed securities on a large scale from December 2008 through March 2010, a policy that appears to have been quite successful in helping to stabilize the economy and support the recovery during that period. Following up on this earlier success, the Committee announced this month that it would purchase additional Treasury securities. In taking that action, the Committee seeks to support the economic recovery, promote a faster pace of job creation, and reduce the risk of a further decline in inflation that would prove damaging to the recovery.

We will not be disuaded from QE2, regardless of the risks, to reneg on the policy measure now would be an admission of impotence for Fed policy, which is a categorical impossibility.

Although securities purchases are a different tool for conducting monetary policy than the more familiar approach of managing the overnight interest rate, the goals and transmission mechanisms are very similar. In particular, securities purchases by the central bank affect the economy primarily by lowering interest rates on securities of longer maturities, just as conventional monetary policy, by affecting the expected path of short-term rates, also influences longer-term rates. Lower longer-term rates in turn lead to more accommodative financial conditions, which support household and business spending. As I noted, the evidence suggests that asset purchases can be an effective tool; indeed, financial conditions eased notably in anticipation of the Federal Reserve's policy announcement.

We have altered the supply of relevent securities and their maturities, pray we don't alter it any further.

Incidentally, in my view, the use of the term "quantitative easing" to refer to the Federal Reserve's policies is inappropriate. Quantitative easing typically refers to policies that seek to have effects by changing the quantity of bank reserves, a channel which seems relatively weak, at least in the U.S. context. In contrast, securities purchases work by affecting the yields on the acquired securities and, via substitution effects in investors' portfolios, on a wider range of assets.

Substitution effects...yes...stocks anyone?

This policy tool will be used in a manner that is measured and responsive to economic conditions. In particular, the Committee stated that it would review its asset-purchase program regularly in light of incoming information and would adjust the program as needed to meet its objectives. Importantly, the Committee remains unwaveringly committed to price stability and does not seek inflation above the level of 2 percent or a bit less that most FOMC participants see as consistent with the Federal Reserve's mandate. In that regard, it bears emphasizing that the Federal Reserve has worked hard to ensure that it will not have any problems exiting from this program at the appropriate time. The Fed's power to pay interest on banks' reserves held at the Federal Reserve will allow it to manage short-term interest rates effectively and thus to tighten policy when needed, even if bank reserves remain high. Moreover, the Fed has invested considerable effort in developing tools that will allow it to drain or immobilize bank reserves as needed to facilitate the smooth withdrawal of policy accommodation when conditions warrant. If necessary, the Committee could also tighten policy by redeeming or selling securities.

Its all under control.

Third, countries that maintain undervalued currencies may themselves face important costs at the national level, including a reduced ability to use independent monetary policies to stabilize their economies and the risks associated with excessive or volatile capital inflows. The latter can be managed to some extent with a variety of tools, including various forms of capital controls, but such approaches can be difficult to implement or lead to microeconomic distortions. The high levels of reserves associated with currency undervaluation may also imply significant fiscal costs if the liabilities issued to sterilize reserves bear interest rates that exceed those on the reserve assets themselves. Perhaps most important, the ultimate purpose of economic growth is to deliver higher living standards at home; thus, eventually, the benefits of shifting productive resources to satisfying domestic needs must outweigh the development benefits of continued reliance on export-led growth.

China, we control the vertical. We control the horizontal. Do. Not. Defy. Us.

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