As QE2 comes to an end and discussion begins as to whether or not there will be QE3, it’s time to revisit a 2002 Ben Bernanke speech titled Deflation: Making Sure “It” Doesn’t Happen Here.  This speech, well before Bernanke became chairman of the Fed, contains some interesting nuggets about what QE3 might look like and also offers some insight into how we’ve turned Japanese over the past nine years.

First, on what QE3 might entail:

However, a principal message of my talk today is that a central bank whose accustomed policy rate has been forced down to zero has most definitely not run out of ammunition. As I will discuss, a central bank, either alone or in cooperation with other parts of the government, retains considerable power to expand aggregate demand and economic activity even when its accustomed policy rate is at zero.  [...]

So what then might the Fed do if its target interest rate, the overnight federal funds rate, fell to zero? One relatively straightforward extension of current procedures would be to try to stimulate spending by lowering rates further out along the Treasury term structure–that is, rates on government bonds of longer maturities.  There are at least two ways of bringing down longer-term rates, which are complementary and could be employed separately or in combination. One approach, similar to an action taken in the past couple of years by the Bank of Japan, would be for the Fed to commit to holding the overnight rate at zero for some specified period. Because long-term interest rates represent averages of current and expected future short-term rates, plus a term premium, a commitment to keep short-term rates at zero for some time–if it were credible–would induce a decline in longer-term rates. A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years). The Fed could enforce these interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields. If this program were successful, not only would yields on medium-term Treasury securities fall, but (because of links operating through expectations of future interest rates) yields on longer-term public and private debt (such as mortgages) would likely fall as well.

On turning Japanese — note the highlighted portions which detail areas where we were different from Japan, but are not so much (if at all) anymore:

First, as you know, Japan’s economy faces some significant barriers to growth besides deflation, including massive financial problems in the banking and corporate sectors and a large overhang of government debt. Plausibly, private-sector financial problems have muted the effects of the monetary policies that have been tried in Japan, even as the heavy overhang of government debt has made Japanese policymakers more reluctant to use aggressive fiscal policies (for evidence see, for example, Posen, 1998). Fortunately, the U.S. economy does not share these problems, at least not to anything like the same degree, suggesting that anti-deflationary monetary and fiscal policies would be more potent here than they have been in Japan.

Second, and more important, I believe that, when all is said and done, the failure to end deflation in Japan does not necessarily reflect any technical infeasibility of achieving that goal. Rather, it is a byproduct of a longstanding political debate about how best to address Japan’s overall economic problems. As the Japanese certainly realize, both restoring banks and corporations to solvency and implementing significant structural change are necessary for Japan’s long-run economic health. But in the short run, comprehensive economic reform will likely impose large costs on many, for example, in the form of unemployment or bankruptcy. As a natural result, politicians, economists, businesspeople, and the general public in Japan have sharply disagreed about competing proposals for reform. In the resulting political deadlock, strong policy actions are discouraged, and cooperation among policymakers is difficult to achieve.

Sayonara.

ADDING a H/T:  I should have pointed out that this 2002 speech of Bernanke’s was referenced in a research note by David Rosenberg last week.  Although almost all of my post is an excerpt, it was Rosie’s citation and commentary that sent me to the Fed’s website to dig it up.  I regret the oversight.

Category: Economy, Federal Reserve

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

24 Responses to “Revisiting Bernanke’s 2002 Playbook”

  1. wally says:

    “retains considerable power to expand aggregate demand”

    He has certainly been proven wrong on that point. He can support the hoarding class, but not the spending class and we are now seeing that the effect of that on aggregate demand is near zero.

    Invictus: My humble opinion is that his statement is correct — it was the implementation/execution of the strategy (such as it was) that was flawed.

  2. red_shoes says:

    …no wonder it’s dark!

  3. Mike in Nola says:

    @Invictus: So what implementation would work, at for raising demand among the non-Maserati-segment of the population whose wealth and income continue to decline?

    Invictus: Well, as I believe the issue is on the demand-side, I would have preferred seeing the stimulus (which I believe was too small to begin with) more targeted toward putting more people to work more quickly. I could have seen myself supporting some type (based on the details) of WPA II — our crumbling infrastructure comes immediately to mind. I’ll also add here that I haven’t seen much in the way of “shared sacrifice” — the “sacrifice” thus far seems to have been on the backs of the American public while all the “sharing” — mostly of government largesse — has been mostly by the corporate kleptocracy.

  4. I like the six word version of this speech:

    If you can not win, cheat!

  5. constantnormal says:

    Bravo! Invictus, you (or rather Ben Bernanke) have made the case in a most convincing manner …

    I DO so hope that this blog item finds it’s way to the eyes of the Fed Chairman …

    Now, the only thing remaining is the form that QE3 will take, and when it will begin … Will it be the Fed purchasing commercial bonds (mostly from Wall Street banksters, mostly repackaged bundles of toxic debt), or will the Fed decide that the economy is in worse trouble, and buy index equity funds?

    As to when it will begin, I say sometime between the start of August and the end of September, with the markets continuing ever-lower along their present slop until the advent of QE3.

    In any case, the double-dip recession seems inevitable at this point, with unemployment starting an unstoppable climb skyward, as consumers retrench in fear and employers respond in kind …

  6. Hopefully Mr. Bernanke and the Fed will listen to what the market’s told them the last time around. Their goal for QE2 was to drive long term rates down, but from the point of their announcement, rates skyrocketed.

    In early April when the press and most naive economists believed the economy could self-sustain, and the collective argument became that there was no need for QE3, rates took their most recent plummet ON THEIR OWN. Let the free market work.

    And while we’re at it, let home prices fall to the point of natural demand by investors and strong buyers who can profit with their own money and not the taxpayer funded incentives. Burn off the excess supply quickly, and let the market bounce back to it’s intrinsic value (what a home costs to build).

  7. constantnormal says:

    @Mike in Nola –

    “So what implementation would work, at for raising demand among the non-Maserati-segment of the population whose wealth and income continue to decline?”

    I believe Bernanke has provided your answer:

    “…in the short run, comprehensive economic reform will likely impose large costs on many, for example, in the form of unemployment or bankruptcy…”

    The fix is going to require considerable pain from both the non-Maserati and the Maserati segments of the population, with a number of those previously soaring above the carnage crashing into it. At this point (perhaps it has been this way throughout), alternative solutions will only delay and deepen the eventual reckoning …

  8. DebbieSmith says:

    Mr. Bernanke merely needs to look at the statistics showing how many Americans are “underwater” to see how the Fed’s policies have impacted Main Street as shown here:

    http://viableopposition.blogspot.com/2011/06/how-underwater-are-american-households.html

    With nearly one-quarter of households having negative equity, it’s going to be a long time before any monetary policy implemented by the Fed has any positive impact on America.

  9. constantnormal says:

    Bernanke is going to find it increasingly difficult to satisfy the Fed’s dual mandate — not the one in the Fed’s charter, to support both the banking system and the general economy, but rather the actual dual mandate, supporting both Wall Street and the White House.

    I doubt that there is sufficient campaign financing in the universe to re-elect Obama in the face of a deteriorating economy, no matter what kind of clown carnival the Repooblicans run against him, or how many wars we are engaged in (which is the classical device used by all Presidents to remain in office).

  10. beaufou says:

    “both restoring banks and corporations to solvency and implementing significant structural change are necessary for Japan’s long-run economic health. But in the short run, comprehensive economic reform will likely impose large costs on many, for example, in the form of unemployment or bankruptcy.”

    Yuk, in an economy saturated with credit and bugged by low wages.
    How about bankruptcy for the too big to fail and allocating funds to non-financial potential employers, I’m sure we have plenty of engineers with plenty of ideas.

    Of course, low interest rates and booming stock markets are a good illusion of stability.

  11. Mike in Nola says:

    @Invictus: I agree with the desirability of a WPA-like program. Problem is, that is not within Bernanke’s power. His means seem pretty limited.

    I don’t personally mind his targeting medium and long Treasury rates, as I’m fairly loaded medium and long Treasuries, but would this actually stimulate the economy? The extremely low middle and long rates last year didn’t seem to do anything, necessitating (in his mind) QE2.

  12. wally says:

    “I could have seen myself supporting some type (based on the details) of WPA II — our crumbling infrastructure comes immediately to mind.”

    But that’s not in any way in the Fed’s power… fiscal programs must come from Congress and Congress is now basically pro-unemployment.

  13. Now you need to dig out the speech where he actually talked about buying company shares and company debt instruments if push really, really came to shove. I think that was where he earned the moniker helicopter Ben

  14. sentry says:

    “A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years). The Fed could enforce these interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields. If this program were successful, not only would yields on medium-term Treasury securities fall, but (because of links operating through expectations of future interest rates) yields on longer-term public and private debt (such as mortgages) would likely fall as well.”

    I’ve seen this before and I can’t reconcile it with the implementation method of QE2. Meaning, in 2002 Bernanke seemed to understand that influencing the bond market is done by focusing on PRICE and not QUANTITY. Why did he forget about this 8 years later? Was he worried the public and politicians would freak if he made the Fed an “unlimited” buyer? That can be the only explanation.

  15. rktbrkr says:

    QEIII will be called anything BUT QEIII

    The task will be to save the big mortgage banksters from armageddon, the US buys their bad mortgages in exchange for Ben Shalom continuing to fund US. US creates massive job creating agency to maintain and hold foreclosed properties off market until supply/demand raises prices and eventually US sells millions of homes at breakeven like GM AIG LOL

  16. Mike in Nola says:

    sentry: I think QE2 wasn’t really about bonds, it was about giving away money to create a stock bubble in hopes that those feeling rich would buy stuff like during the NASDAQ and housing bubbles. Obviously didn’t happen, as the really rich can afford not to spend, except on the occasional Maserati. It is the middle and lower classes that have to spend, but his policies don’t seem to be geared to putting money into their hands.

  17. DeDude says:

    Seems to me like reduced rates of the 2-year treasury has failed to drag the 30-year down the way he predicted. How much further could he drag the 2-year yield and why would that be expected to have much of any influence on the 30-year yield (when we in the last year have gone from 1:5 to a 1:10 ration of yields between the 2- and 30- year bonds). Expectations are for an increase in rates and nobody is interested in getting into the long bonds regardless if how little the 2-year gives them. As long as the concern is more about return of investment than return on investment we are stuck.

    On another note, I think they may have understood that QE2 boasted commodities and slowed the economy via higher gas prices. I think the market is overestimating the probability and timing of any QE3 intervention. Some will be surprised and that means some will be burned.

  18. rktbrkr says:

    ZH talks about how QEII was (mis)directed to European banks.

    It’s 10AM, do you know where your money is? Not with the FED fighting timely revelation of public records

    http://www.zerohedge.com/article/exclusive-feds-600-billion-stealth-bailout-foreign-banks-continues-expense-domestic-economy-

  19. DeDude says:

    Invictus; I agree that the only way to get consumption increased (and the economy growing again) is to force it via government investing in infrastructure. But that would require that you convince the GOP that it is more important to save the US economy than it is to sink reelection of Obama. Good luck with that one.

  20. Mark A. Sadowski says:

    We need to get beyond QE. The interest rate and credit channels are toast. But that doesn’t mean monetary policy is impotent, after all it was devaluation of the dollar in 1933 that set off the greatest four year peacetime growth in real GDP in US history (an average of 9.5% per year). We need to shift focus to the asset price, exchange rate and inflation expectations channels. Thus price level targeting or nominal GDP level targeting is the way to go.

    Bernanke had a better speech on price level targeting in 2003:

    “What I have in mind is that the Bank of Japan would announce its intention to restore the price level (as measured by some standard index of prices, such as the consumer price index excluding fresh food) to the value it would have reached if, instead of the deflation of the past five years, a moderate inflation of, say, 1 percent per year had occurred. (I choose 1 percent to allow for the measurement bias issue noted above, and because a slightly positive average rate of inflation reduces the risk of future episodes of sustained deflation.) Note that the proposed price-level target is a moving target, equal in the year 2003 to a value approximately 5 percent above the actual price level in 1998 and rising 1 percent per year thereafter. Because deflation implies falling prices while the target price-level rises, the failure to end deflation in a given year has the effect of increasing what I have called the price-level gap (Bernanke, 2000). The price-level gap is the difference between the actual price level and the price level that would have obtained if deflation had been avoided and the price stability objective achieved in the first place.”

    And:

    “A concern that one might have about price-level targeting, as opposed to more conventional inflation targeting, is that it requires a short-term inflation rate that is higher than the long-term inflation objective. Is there not some danger of inflation overshooting, so that a deflation problem is replaced with an inflation problem? No doubt this concern has some basis, and ultimately one has to make a judgment. However, on the other side of the scale, I would put the following points: first, the benefits to the real economy of a more rapid restoration of the pre-deflation price level and second, the fact that the publicly announced price-level targets would help the Bank of Japan manage public expectations and to draw the distinction between a one-time price-level correction and the BOJ’s longer-run inflation objective. If this distinction can be made, the effect of the reflation program on inflation expectations and long-term nominal interest rates should be smaller than if all reflation is interpreted as a permanent increase in inflation.”

    http://www.federalreserve.gov/boarddocs/speeches/2003/20030531/default.htm

  21. gordo365 says:

    Another approach for QE3 – would be to enforce negative interest rates. Charge people to save money. That will chase even MORE pension funds and fixed income seniors into muni-funds and gold stocks.

    Mission accomplished.

  22. wildebeest says:

    It is strange given Bernanke’s comments back then that the Fed didn’t actually set a target rate on long bonds during QE2. There targeted quantity rather than price. Therefore, if controlling longer term rates was the goal it was a failure.

  23. HEHEHE says:

    I think the investment gameplan is clearly spelled out by Bernanke – be long stocks/commdoities when QE is announced; be short or in cash when QE is taken off the table. QE is now the substitute for natural growth. QE has more of an affect on asset prices because the “money” is being placed directly into banks hands and they are investing rather than lending.