In his speech today Bernanke Chairman of the Federal Reserve said of recent developments in Fed policy : “In my view, the use of the term "quantitative easing" to refer to the Federal Reserve's policies is inappropriate. Quantitative easing typically refers to policies that seek to have effects by changing the quantity of bank reserves. In contrast, securities purchases work by affecting the yields on the acquired securities.”
So it’s not quantitative easing after all (QE2) but a security purchase program (ASPP2). ASP works by buying Treasury Securities forcing prices up. Since bonds have fixed dollar coupons, yields fall as a percentage in the process. So what? What does this actually achieve other than creating a false market in yields and risk spreads? To announce a further round of purchases as the US economy grows at a rate of 3% this year doesn’t make sense.
Bernanke believes that “lower long term rates lead to more accommodative financial conditions which support household and business spending.” There is no evidence to support this proposition. In the 1980’s the Bank of England considered that interest rate changes had no impact on consumer spending. It took time to realise extensive home ownership and high mortgages LTV’s were not in the Keynesian conscience when the old policy models of “interest rate transmission mechanisms” were developed.
QE or ASPs work by increasing short term liquidity in the banking system. As Bernanke said, “financial conditions eased notably in anticipation of the Federal Reserve's policy announcement.” FInancial conditions eased, just as feet get wet before the flood, it’s not rocket science or enlightened economics. More cash equals more liquidity.
Bernanke hints at an inflation target. “The Committee remains unwaveringly committed to price stability and does not seek inflation above the level of 2 percent or a bit less”. One always knew Bernanke was a closet IT (inflation target man), he wrote the book on the subject after all. “Two per cent or a bit less” as a policy statement lacks an element of sophistication that can’t be represented in a fan chart. A little more work is needed here.
The real fascination with Bernanke, is the belief that currency adjustments will solve the problems of the US external deficit and somehow the $600 billion US trade deficit this year will be stabilised by a more flexible exchange rate regime. If only the Renmimbi were revalued is the proposition, the record $270 billion trade deficit forecast this year with China would be eliminated.
The chart demonstrates the extent of the international imbalance. This year the US remains the engine of international trade as the economies of the world recover. Britain, India, Spain and France offer a modest assist. Russia and Saudi Arabia benefit from the natural resource surge in energy prices but the real trade beneficiaries are China and Germany. The China surplus should be netted against the Hong Kong deficit but therein is the detail that leaves Germany as the real international villain.
When Bernanke calls for flexible exchange rate policies, is this just a message for the Middle Kingdom or is it a denunciation of the Euro? After all, pegged rates in Euroland ensure the German export miracle continues at the expense of all around. JKA
Inflation Targeting: Lessons from the International Experience Ben Bernanke
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