Talk is cheaper

July 20, 2011

The Federal Reserve is hinting that if it should come to further monetary easing to stimulate growth, it might prefer to talk the talk rather than walk the walk.

Fed Chairman Ben Bernanke said last week the central bank is “ready to respond” if the recovery stalls. While such a move isn’t imminent, he made clear that even with interest rates near zero, the Fed has plenty of options to spur growth if it needs to. When Bernanke in August 2010 spelled out alternative policy measures before launching the Fed’s second round of quantitative easing — $600 billion worth of Treasuries purchases — he listed bond buying first.

But in testimony to Congress last week, communications steps topped the list:

One option would be to provide more explicit guidance about the period over which the federal funds rate and the balance sheet would remain at their current levels.

In his press conference after the Fed’s June meeting, Bernanke offered several other communications menu items, saying the Fed could give guidance on how long it plans to keep buying securities to hold its balance sheet at its current expanded level, or give a fixed date for how long it plans to keep interest rates exceptionally low.

Is Bernanke’s re-ordering of Fed policy tools evidence of preference?

“This may be over-analysis,” wrote J.P.Morgan economist Michael Feroli, who nevertheless believes the Fed will lean toward communications as its next method to loosen monetary policy further should conditions warrant.

It certainly would make sense: quantitative easing was highly controversial both internationally, where it was seen by many as recklessly stirring inflation and domestically, where among other criticism, it has been misconstrued as as profligate government spending.

In addition, the Fed has already embarked on asset purchases on a grand scale, and the effects of more buying or adding to an already bloated Fed balance sheet are unknown.

In another possible sign the Fed is considering bolstering its easy-money promise, Atlanta Fed President Dennis Lockhart said this week the central bank’s “extend period” pledge could go “much longer” than just two or three meetings.

What the Fed can do is to sustain its current policy until it’s clear that we are seeing really much stronger growth and we’re seeing progress in bringing unemployment down.


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