Federal Reserve Chairman Ben S. Bernanke said the U.S. central bank “will do all that it can” to ensure a continuation of the economic recovery and that more securities purchases may be warranted if growth slows.
The Federal Open Market Committee “is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly,” the Fed chairman said today at the Kansas City Fed’s annual monetary symposium held in Jackson Hole, Wyoming.
Bernanke’s speech follows a drumbeat of negative economic reports, including a reduced estimate of second-quarter growth released today, that have prompted economists including Harvard University’s Martin Feldstein to warn that the risks of a renewed recession are rising. Still, the Fed chairman stopped short of signaling that further easing would come as soon as Sept. 21, when Fed officials next meet.
“He is trying to buy time,” said Ethan Harris, head of Developed Markets Economics at Bank of America-Merrill Lynch Global Research in New York. “He is acknowledging that the economy is weaker and is saying they have policy options going forward.”
Handoff Under Way
The Fed chairman gave a detailed analysis of the economy and said growth during the past year has been “too slow” and unemployment too high. Even so, he said a handoff from fiscal stimulus and inventory re-stocking to consumer spending and business investment “appears to be under way.” He also said that the “preconditions” for a pickup in growth in 2011 “appear to remain in place.”
Stocks rallied on the prospect of additional Fed support, and Treasuries declined. The Standard & Poor’s 500 Index rose 1.3 percent to 1,061.13 at 2:19 p.m. in New York. The yield on the 10-year Treasury note climbed to 2.63 percent from 2.48 percent late yesterday.
The Commerce Department today cut its estimate for U.S. gross domestic product in the second quarter to an annual pace of 1.6 percent from an initially reported 2.4 percent. The revised figure exceeded the median forecast for a 1.4 percent expansion in a Bloomberg News survey of economists.
“There’s still a significant risk, maybe one chance in three, that there will be a double dip, real GDP falling, before we’re in the clear,” Feldstein, a member of the committee at the National Bureau of Economic Research that dates the beginning and end of recessions, said in an interview. “We see a fragile economy that is growing at a slower pace.”
Bernanke said the risk of an “undesirable rise in inflation or of significant further disinflation seems low.” He said the Fed has several tools if prices decelerate or job growth stagnates, including shifting the composition of its bond reinvestment strategy.
“The Fed is ready to take action if needed,” said John Silvia, chief economist at Wells Fargo Securities LLC in Charlotte, North Carolina. “They are aware the economy is not doing as well as expected.”
The Federal Open Market Committee on Aug. 10 put its exit strategy on hold and decided to purchase Treasury securities to keep the central bank’s portfolio from shrinking as its mortgage bonds mature. The committee set a floor of $2.05 trillion for their holdings of securities.
“The FOMC’s recent decision to stabilize the Federal Reserve’s securities holdings should promote financial conditions supportive of recovery,” Bernanke said today. “Additional purchases of longer-term securities, should the FOMC choose to undertake them, would be effective in further easing financial conditions.”
Bernanke provided his most detailed analysis yet of three policy options open to the Fed: further purchases of securities, a change in its policy statement and a reduction of the interest rate the Fed pays on banks’ excess reserves. He dismissed a fourth option proposed by some economists to raise the Fed’s inflation target.
“At this juncture, the committee has not agreed on specific criteria or triggers for further action,” he said. Still, he said the Fed will “strongly resist” any further decline in inflation, and “the FOMC will do all that it can to ensure continuation of the economic recovery.”
Dean Croushore, a former Philadelphia Fed economist, said disagreements among policy makers may delay further policy moves.
“There’s a big split” among FOMC members “between people concerned about inflation rising in the future and those concerned about deflation,” said Croushore, who is now chairman of the economics department at the University of Richmond in Virginia. “The Fed is unlikely to make any major changes soon.”
Bernanke, explaining the Fed’s Aug. 10 decision, said that lower long-term interest rates increased mortgage refinancing, causing a more rapid prepayment of the Fed’s $1.1 trillion in mortgage-backed securities holdings.
“Any further weakening of the economy that resulted in lower longer-term interest rates and a still-faster pace of mortgage refinancing would likely lead in turn to an even more- rapid runoff of MBS from the Fed’s balance sheet,” Bernanke said. “Thus, a weakening of the economy might act indirectly to increase the pace of passive policy tightening -- a perverse outcome.”
Economists estimate that the unemployment rate will rise to 9.6 percent in August from 9.5 percent in June and July, according to the median forecast in a Bloomberg News survey. The Fed’s preferred inflation indicator, the personal consumption expenditures price index, minus food and energy, rose at a 1.1 percent annual rate in the second quarter.
Fed officials said in June their longer-run preference range for inflation is 1.7 percent to 2 percent.
Consumer confidence has been sapped by unemployment close to a 26-year high. Confidence rose less than forecast in August from an eight-month low, a Thomson Reuters/University of Michigan index of showed today.
“Incoming data suggest that the recovery of output and employment in the United States has slowed in recent months, to a pace somewhat lower than most FOMC participants projected earlier this year,” Bernanke said. “Consumer spending may continue to grow relatively slowly in the near term.”
Intel Corp., the world’s biggest chipmaker, today cut its forecasts for third-quarter revenue and gross profit margin, citing weaker demand for personal computers in mature markets. The announcement follows reports that capital spending, one of the few bright spots in the recovery, is weakening.
“Investment in equipment and software will almost certainly increase more slowly over the remainder of this year, though it should continue to advance at a solid pace,” Bernanke said.
The Kansas City Fed is hosting central bankers from more than 40 countries including Brazil, Malawi and New Zealand this year as well as economists from firms such as Bank of America Corp., Morgan Stanley and International Strategy & Investment Group Inc.
Bernanke explained how the Fed’s purchases of bonds are helping the economy by lowering borrowing costs.
“The Fed’s strategy relies on the presumption that different financial assets are not perfect substitutes in investors’ portfolios,” he said. Its purchases of Treasuries should push investors into other types of bonds with similar types of risks, lowering their yields as well, he said.
Risks to the approach include a lack of “very precise knowledge” of the effects of the purchases and the chance that expanding the Fed’s balance sheet further “could reduce public confidence in the Fed’s ability to execute a smooth exit from its accommodative policies at the appropriate time,” Bernanke said.
A second option, Bernanke said, would be to communicate that the Fed will keep its benchmark rate low for a “longer period than is currently priced in markets.” While the Bank of Canada’s 2009 adoption of the strategy “seemed to work well” there, a risk is that investors “may not fully appreciate that any such commitment must ultimately be conditional on how the economy evolves,” Bernanke said.
Lowering the interest rate on banks’ deposits at the Fed to 0.10 percentage point or zero from 0.25 percentage point is a third choice, Bernanke said. The effect of such a move on financial conditions “in isolation would likely be relatively small,” and it risks making the market for overnight loans, or federal funds, “much less liquid,” he said.
Back-to-back quarters of growth below 2 percent are likely to push unemployment higher and put more downward pressure on inflation, which is already lower than the Fed’s longer-term desired range, economists say.
The Fed has already experienced about $140 billion of repayment of mortgage and agency debt, he said.
“Although mortgage prepayment rates are difficult to predict, under the assumption that mortgage rates remain near current levels, we estimated that an additional $400 billion or so of MBS and agency debt currently in the Fed’s portfolio could be repaid by the end of 2011,” the Fed chairman said.
Policy makers in August decided that allowing the Fed’s balance sheet to shrink when the economic outlook “had weakened somewhat was inconsistent with the committee’s intention to provide the monetary accommodation necessary to support the recovery,” Bernanke said in a reference to the FOMC.
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