MacroScope

We heard it more than once at today’s hearing of the Joint Economic Committee featuring Fed Chairman Ben Bernanke: the central bank’s low interest rate policies are allowing Congress to delay tough decisions on long-term spending.

As U.S. senator Dan Coats asked pointedly: “Is the Fed being an enabler for an addiction Congress can’t overcome?”

Yet, if you read the subtext of Bernanke’s testimony closely, it may actually be Congress that is enabling a loose Federal Reserve.

That’s because it is the very fiscal tightening mandated by Congressional inaction that is forcing the Fed to continue stimulating growth. Chicago Fed President Charles Evans said on Tuesday the economy could be expanding as quickly as 3.5 percent were it not for the fiscal drag from Washington.

Bernanke echoed that sentiment in his testimony on Wednesday:

The Congressional Budget Office estimates that the deficit reduction policies in current law will slow the pace of real GDP growth by about 1-1/2 percentage points during 2013, relative to what it would have been otherwise. In present circumstances, with short-term interest rates already close to zero, monetary policy does not have the capacity to fully offset an economic headwind of this magnitude.

Financial markets this will be keenly focused on congressional testimony from Fed Chairman Ben Bernanke and minutes from the central bank’s April 30-May 1 meeting, particularly given a thin data calendar. The latter may be the more interesting one, since it will offer hints into how far Fed officials are leaning in a direction of curbing the pace of its bond-buying stimulus, potentially late this summer.

The economic backdrop has been just mixed enough to leave policymakers cautious about taking their foot off the gas. Still, if we get a few more months of strength in the labor market, Fed officials may just be able to say “substantial progress” has been made in the outlook for the labor market – their stated precondition for an end to asset buys.

Still, Harm Bandholz at Unicredit says markets should not confuse a debate about tapering bond buys with some immediate reversal of the Fed’s policy of ultra low rates.

Ask top Federal Reserve officials about adopting a target for non-inflation adjusted growth, or nominal GDP, and they will generally wince. Proponents of the awkwardly-named NGDP-targeting approach say it would be a more powerful weapon than the central bank’s current approach in getting the U.S.economy out of a prolonged rut.

This is what Fed Chairman Ben Bernanke had to say when asked about it at a press conference in November 2011:

So the Fed’s mandate is, of course, a dual mandate. We have a mandate for both employment and for price stability, and we have a framework in place that allows us to communicate and to think about the two sides of that mandate. We talked today – or yesterday, actually – about nominal GDP as an indicator, as an information variable, as something to add to the list of variables that we think about, and it was a very interesting discussion. However, we think that within the existing framework that we have, which looks at both sides of the mandate, not just some combination of the two, we can communicate whatever we need to communicate about future monetary policy. So we are not contemplating at this date, at this time, any radical change in framework. We are going to stay within the dual mandate approach that we’ve been using until this point.

I asked Fed Chairman Ben Bernanke during his quarterly press conference this week if the central bank had its own estimate for the implicit subsidy that banks considered too big to fail receive in the form of cheaper borrowing. Senator Elizabeth Warren had confronted him at a recent hearing with a Bloomberg estimate of $83 billion which itself was derived from an IMF study. At the time, he dismissed her concern: “That’s one study Senator, you don’t know if that’s an accurate number.”

At the press briefing, Bernanke said the Fed does not have its own figures for Wall Street’s too-big-to-fail subsidy, in part because there were too many factors that made it difficult to calculate.

However, this time around, he seemed more sympathetic to Warren’s concerns than he had at the Senate Banking Committee hearing.

Watching Ben Bernanke testify before Congress in recent years, it’s hard to shake the feeling that this is a Fed Chairman who has been largely abandoned by his own party. Hearing after hearing, Bernanke receives steady support and praise Democrats for his efforts to stimulate a fragile economic recovery – and takes constant heat from Republicans for what they perceive as the possible dangers of low interest rates.

Many people forget Bernanke was first nominated to his current role by a conservative Republican president, George W. Bush. Bush, though he was reappointed to a second term by President Barack Obama. Bush first named Bernanke to the Fed’s board in 2002, then brought him to the White House to lead his Council of Economic Advisors.

In his recent biannual testimony on monetary policy, Bernanke had quite the exchange with Bob Corker, a Republican Senator from Tennessee. The tone of his question was immediately confrontational:

That’s not a typo in the headline. In a recent speech that took some mental gymnastics to absorb, Federal Reserve Chairman Bernanke countered critics of his low rates policy by arguing that a loose monetary policy is the best way to ensure rates can rise to more normal levels.

Why? Because interest rates will naturally move higher once stronger economic growth leads to higher rates of return on investment, Bernanke said. Here’s his argument:

One might argue that the right response to these risks is to tighten monetary policy, raising long-term interest rates with the aim of forestalling any undesirable buildup of risk. I hope my discussion this evening has convinced you that, at least in economic circumstances of the sort that prevail today, such an approach could be quite costly and might well be counterproductive from the standpoint of promoting financial stability. Long-term interest rates in the major industrial countries are low for good reason: Inflation is low and stable and, given expectations of weak growth, expected real short rates are low. Premature rate increases would carry a high risk of short-circuiting the recovery, possibly leading–ironically enough–to an even longer period of low long-term rates. Only a strong economy can deliver persistently high real returns to savers and investors, and the economies of the major industrial countries are still in the recovery phase.

Federal Reserve Chairman Ben Bernanke may be keeping quiet about his future plans, but he sure doesn’t sound like someone planning to seek Senate support for a third term at the helm of the U.S. central bank.

In unapologetic and sometimes testy exchanges before the Senate Banking Committee on Tuesday, the Fed chief defended his record and dismissed one Senate critic in unusually blunt terms.

“None of the things you said are accurate,” Bernanke told Bob Corker, a Republican senator from Tennessee, who accused the Fed of deliberately starting a global currency war and of printing money to bail out big Wall Street banks.

Tim Ahmann contributed to this post

Suddenly top Wall Street firms are talking about the possibility that the Fed might adopt numerical thresholds for asset purchases, in the same way it has done with interest rates more broadly.

Writes Mike Feroli, chief economist at JP Morgan and a former NY Fed staffer:

Perhaps the most interesting element of Fed policy at the current juncture is how they communicate the conditions that will lead to a slowing or a halt in asset purchases. The speed with which the Committee produced the numerical threshold rate guidance is a reminder that the Bernanke Fed can get their homework done early, but even so we do not look for any news on this front next week.

First, the discussion of this topic is still in its infancy; even the numerical threshold guidance took a few months of debate to finalize. Second, since the introduction of the Chairman’s press conference the FOMC has shown a strong preference to make big decisions – and ones potentially subject to public misunderstanding – at meetings associated with a press conference. There is no press conference scheduled for next week’s meeting. Third, given the complicated task of quantifying the costs of balance sheet expansion, it’s not even certain the Fed will ever communicate the economic conditions that would slow or stop their asset purchases.

This post was based on reporting by Leika Kihara in Tokyo

Japan has crossed the monetary rubicon: the government is actively intervening in the affairs of the central bank, pressuring it to more aggressively tackle a prolonged bout of deflation and economic stagnation. The Bank of Japan is expected to discuss raising its inflation target from the current 1 percent level during its next rate decision on January 21-22.

Overnight, a Japanese newspaper reported the finance ministry and the central bank were considering signing a policy accord that would set as a common goal not just achieving 2 percent inflation but also steady job growth.

Key Japanese policymakers played down the prospect of making the BOJ responsible for stable employment like the U.S. Federal Reserve, but said a 2 percent inflation target will be at the heart of a new policy accord with the central bank.

Updates with Fed decision

The Federal Reserve on Wednesday took the unprecedented step of tying its low rate policy directly to unemployment, saying it will keep rates near rock bottom until the jobless rate falls to 6.5 percent. That’s as long as inflation, the other key parameter of policy, does not exceed 2.5 percent.

Jan Hatzius, chief economist at Goldman Sachs, however, said in a research note published ahead of the decision that the shift may not be very effective.

Would such a move be a good idea? We’re not so sure. Calendar guidance may be theoretically flawed, but it is working reasonably well in practice. Fed officials have managed to keep expectations for the funds rate in the next few years pinned near zero, and the market now understands that this is more of a commitment to the promotion of future economic recovery than an expectation of future economic weakness.