Monday, August 29, 2011

No surprises from Bernanke

Fed Chairman Ben Bernanke’s speech from Jackson Hole over the weekend contained no surprises. In particular there was no new stimulus announced which will have disappointed some.

Bernanke acknowledged that the recovery was proving to be slower than expected and that the temporary factors he has alluded to previously account “for only a portion of the economic weakness that we have observed. Consequently, although we expect a moderate recovery to continue and indeed to strengthen over time, the committee has marked down its outlook for the likely pace of growth over coming quarters.”

He made it clear, without going into any new detail, that the Fed has tools at its disposal and will use them, should conditions warrant: “The Committee will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools as appropriate to promote a stronger economic recovery in a context of price stability.”

The price stability context is an important one. Conditions in 2011 are significantly different to those that prevailed in 2010. Last year as QE2, was being considered, core inflation was below 1% and falling. In 2011 it is over 2% (PCE deflator) and rising. That makes QE3 a significantly different proposition to QE2. Throughout the speech every reference Bernanke makes to employing further stimulus is qualified that any action needs to be in the context of price stability. That does not rule QE3 out, but neither is it a done deal.

With regard to the longer run prospects for the economy, we agree with everything Bernanke says. He makes the point that building a stronger recovery in the US is not just a monetary policy issue: “...most of the economic policies that support robust economic growth in the long run are outside the province of the central bank”. A stronger more sustainable economic recovery needs a broad policy response. No brainer.

With regard to fiscal policy he states “...US fiscal policy must be placed on a sustainable path that ensures that debt relative to national income is at least stable, or preferably, declining over time”. However, he stresses the importance of a balanced approach: “Although the issue of fiscal sustainability must urgently be addressed, fiscal policymakers should not, as a consequence, disregard the fragility of the current economic recovery.”

As far as we are concerned, Bernanke said all the right things. Importantly, while he did not offer up new stimulus at the weekend, he is obviously prepared to go there if needed. It is interesting in that regard that the September FOMC meeting has been extended from its scheduled one day to two. But there were equally important messages for policymakers in his speech. In short, monetary policy can’t do this alone and there is considerable work still ahead in building an enduring recovery.