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Bernanke to Congress: No Premature Tightening of Monetary Policy

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Bernanke to Congress: No Premature Tightening of Monetary Policy

In testimony today before the Joint Economic Committee, Fed Chairman Ben Bernanke described why a “premature tightening of monetary policy” would be a mistake. The Chairman of the Joint Economic Committee, Representative Kevin Brady, asked Chairman Bernanke about the Fed’s exit strategy and when an exit process might occur. Chairman Bernanke emphasized that it would depend on future economic data, especially employment data. When there is finally strong evidence of improvements in the labor market, the Fed may then start the long process of tightening. The first step, according to Chairman Bernanke, would be to slow the pace of its asset purchases (i.e. winding down QE).

Rep. Brady provided an opening statement that did a good job at describing the downsides and the risks of the Fed’s “extraordinary monetary actions.” He also highlighted how the extraordinarily low interest rates have been “punishing seniors, savers, pension funds and insurance products.” He ended his statement by saying that the Fed “should begin now to carefully exit from its extraordinary monetary actions.”

It should also be noted that Rep. Brady introduced the Sound Dollar Act of 2012 which would replace the Fed’s dual mandate of controlling unemployment and inflation with just a single mandate of controlling inflation.

Below are excerpts of Rep. Brady’s opening statement that are most relevant to savers:

Thank you for your service as Chairman of the Federal Reserve. You deserve great credit for the leadership that calmed America’s financial crisis in 2008.

Four and half years after that crisis and nearly four years after the recession ended, the Fed is still engaging in extraordinary monetary actions and may continue doing so well into the future.

[...]

Extraordinarily low interest rates have clearly boosted housing prices and housing construction with positive economic effects. However, those same low rates are punishing seniors, savers, pension funds and insurance products. Families may now feel more secure about their house, but less secure about their income and job prospects.

As for the Fed's unemployment rate targeting, quantitative easing has run out of steam. Long-term interest rates are already at a near 70-year low. Banks have $1.9 trillion in excess reserves at the Fed, and non-financial corporations have $1.5 trillion sitting on the sidelines. More liquidity and lower long-term rates cannot solve the problems that are holding back job creation in America.

[...]

I don't question the intention of current Fed policy to fulfill its dual mandate, but I question the policy’s effects on employment and worry about its future risks.

[...]

Given these risks and the limits to monetary policy in the current economic recovery, the Federal Reserve should begin now to carefully exit from its extraordinary monetary actions and return to a more predictable, rules - based monetary policy that focuses on maintaining the purchasing power of the U.S. dollar over time.

Chairman Bernanke acknowledged the costs and risks of low interest rates in his opening statement. Below are excerpts of Chairman Bernanke’s opening statement which acknowledged these and described why these still don’t warrant any change of policy:

the Committee is aware that a long period of low interest rates has costs and risks. For example, even as low interest rates have helped create jobs and supported the prices of homes and other assets, savers who rely on interest income from savings accounts or government bonds are receiving very low returns. Another cost, one that we take very seriously, is the possibility that very low interest rates, if maintained too long, could undermine financial stability. For example, investors or portfolio managers dissatisfied with low returns may "reach for yield" by taking on more credit risk, duration risk, or leverage. The Federal Reserve is working to address financial stability concerns through increased monitoring, a more systemic approach to supervising financial firms, and the ongoing implementation of reforms to make the financial system more resilient.

Recognizing the drawbacks of persistently low rates, the FOMC actively seeks economic conditions consistent with sustainably higher interest rates. Unfortunately, withdrawing policy accommodation at this juncture would be highly unlikely to produce such conditions. A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further. Such outcomes tend to be associated with extended periods of lower, not higher, interest rates, as well as poor returns on other assets. Moreover, renewed economic weakness would pose its own risks to financial stability.

Because only a healthy economy can deliver sustainably high real rates of return to savers and investors, the best way to achieve higher returns in the medium term and beyond is for the Federal Reserve--consistent with its congressional mandate--to provide policy accommodation as needed to foster maximum employment and price stability. Of course, we will do so with due regard for the efficacy and costs of our policy actions and in a way that is responsive to the evolution of the economic outlook.

Finally, the meeting ended today with Rep. Duffy asking Chairman Bernanke if he plans to accept a third term as Chairman if the President asks him to serve. As you might expect, Chairman Bernanke replied by saying that he’s “not prepared to answer that question now.” It’s important to remember that if Chairman Bernanke chooses to step down, his replacement is likely to be more of an inflation dove. So it might actually be better for savers if he decides to stay for a third term.

In addition to Chairman Bernanke’s testimony today, the Fed released the FOMC April 30/May 1 meeting minutes. The minutes suggested that there are “a number of participants” who are wanting to slow the pace of asset purchases. Here’s an excerpt from the minutes:

A number of participants expressed willingness to adjust the flow of purchases downward as early as the June meeting if the economic information received by that time showed evidence of sufficiently strong and sustained growth; however, views differed about what evidence would be necessary and the likelihood of that outcome.

It still comes down to improvements in economic data, and even if we get data that shows “strong and sustained growth”, there will still be debate in the Fed about if that growth is sufficient. The minutes warned that “normalization still appeared to be well in the future.” In summary, the tightening process at the Fed may still be a long way off, and when it starts, it may still take awhile before it leads to rate hikes.



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