Ben Bernanke Just Gave A Superb Speech That Explained All Of His Biggest Decisions
REUTERS/ Tim Chong
At the Annual Dinner of the National Economists Club, Federal Reserve chairman Ben Bernanke gave a speech that walked through the reasoning for all of the Fed's big actions since the financial crisis.
He explained why the Fed has used unconventional monetary policy in the aftermath of the Great Recession. The ultimate goals of these policies has been to shape the public's policy expectations to convince it that it would keep policy loose for an extended period of time.
Here are the key themes he talked about:
Forward Guidance
Bernanke emphasized the importance of clearly articulating the future of Fed policy using forward guidance. This was particularly true after the great recession when the Fed's usual policy tool, short-term interest rates, had limited effectiveness due to the zero-lower bound. The FOMC attempted to lower long-term rates by communicating to the market that short-term rates would be low for a long period of time. This was the goal of forward guidance.
At first, the Fed did this in a qualitative sense, but eventually started using more date-specific guidance to communicate to the market. However, this guidance also had its own limitation:
Although the date-based forward guidance appears to have affected the public's expectations as desired, it did not explain how future policy would be affected by changes in the economic outlook--an important limitation. Indeed, the date in the guidance was pushed out twice in 2012--first to late 2014 and then to mid-2015--leaving the public unsure about whether and under what circumstances further changes to the guidance might occur.
To offset this, the Fed recently moved to a more state-contingent guidance, noting that the Fed would not consider raising rates while unemployment was above 6.5% and inflation was near 2%. Bernanke emphasized these were thresholds, not triggers, meaning that hitting the targets would not automatically cause rate increases but were a necessary level for rates to rise.
Large Scale Asset Purchases (LSAPs)
The Fed also implemented a new, unconventional monetary policy tool that had the same goal of lowering long-term rates, but did so in a different manner. Instead of credibly informing the market that short-term rates would be low for a longer period of time, LSAPs reduced long-term rates by purchasing securities. This reduces the supply and drives up the value of them, lowering rates. Bernanke lays this dual strategy of forward guidance and LSAPs clearly in his speech:
[F]orward rate guidance affects longer-term interest rates primarily by influencing investors' expectations of future short-term interest rates. LSAPs, in contrast, most directly affect term premiums... As both forward rate guidance and LSAPs affect longer-term interest rates, the use of these tools allows monetary policy to be effective even when short-term interest rates are close to zero