August 27, 2010
Chairman Bernanke kicked off the annual symposium in Jackson Hole with a blueprint for the future course of monetary policy. In his opinion, "the recovery of output and employment in the United States has slowed in recent months, to a pace somewhat weaker than most FOMC participants projected earlier this year." (The central tendency of the Fed's forecast in July for 2010 is 3.0% to 3.5%). He also noted that "despite the weaker data seen recently, the preconditions for a pickup in growth in 2011 appear to remain in place."
Bernanke listed four options the Fed has in its arsenal with the costs and benefits of each alternative. First, the Fed can purchase longer term securities and increase the size of the balance sheet. However, Mr. Bernanke indicated that this strategy works best during times of "financial stress." He also added that large purchases of additional securities would leave the public less confident about the Fed's ability to manage a smooth exit. The reduction of confidence would translate into an "undesired increase in inflation expectations." Bernanke stressed that the Fed has developed several tools to ensure a smooth exit and Fed officials have spoken extensively about these tools to moderate concerns of the public. Second, Mr. Bernanke noted that the Fed could communicate to investors that it "anticipates keeping the target for the federal funds rate low for a longer period than is currently priced in the markets." The main drawback of this tool is that it may be a challenge to convey the FOMC's intentions with precision. Third, the Fed could reduce interest rates it pays on excess reserves (currently 25 bps). Bernanke sees this route as fraught with the potential of reducing liquidity of the federal funds market. Fourth, he mentioned a controversial solution - announcing a medium term inflation target that is above a level consistent with price stability. Bernanke considers this option inappropriate for the United States and sees it suitable in situations of an extended period of deflation. He supported this opinion with the fact that inflation and inflation expectations are within a range of price stability in the United States and would not require this strategy. Given these opinions about the alternatives the Fed has, it appears that purchases of securities will probably prevail, if necessary.
Bernanke's description of the circumstances under which the Fed would consider further easing of monetary policy is the crux of the speech. These remarks offer guidance pertaining to the course of near term monetary policy:
"First, the FOMC will strongly resist deviations from price stability in the downward direction. Falling into deflation is not a significant risk for the United States at this time, but that is true in part because the public understands that the Federal Reserve will be vigilant and proactive in addressing significant further disinflation. It is worthwhile to note that, if deflation risks were to increase, the benefit-cost tradeoffs of some of our policy tools could become significantly more favorable.
Second, regardless of the risks of deflation, the FOMC will do all that it can to ensure continuation of the economic recovery. Consistent with our mandate, the Federal Reserve is committed to promoting growth in employment and reducing resource slack more generally. Because a further significant weakening in the economic outlook would likely be associated with further disinflation, in the current environment there is little or no potential conflict between the goals of supporting growth and employment and of maintaining price stability."
Real GDP Growth Slows in Q2, Second-Half Likely to Mimic This Trend
Real GDP of the U.S. economy grew at annual rate of 1.6% in the second quarter, revised down from the advance estimate of 2.4%. The upward revision of imports to a 32.4% increase from the earlier estimate of a 28.8% gain was the major reason for the downward revision, in addition to a smaller accumulation of inventories ($63.2 billion vs. $75.7 billion in the advance estimate) and a nearly flat reading of outlays on non-residential structures (+0.4% vs. +5.2%). Partly offsetting positive contributions came from upward revisions of consumer spending (+2.0% vs. +1.6% in the advance report) and equipment and software spending (+24.9% vs. +21.9% in advance estimate).
Corporate profits increased 4.6% in the second quarter vs. a 10.6% gain in the first quarter. Domestic non-financial industries (+8.1%) made the larger contribution to corporate profits in the second quarter, while profits of the financial industry inched down 0.1% and profits from abroad rose 1.4%.
A tepid increase in real GDP is projected for the second-half of the year, putting the Q4-to-Q4 increase at 2.2% after a nearly flat reading in 2009. Bernanke indicated that the Fed stands ready to provide additional financial accommodation to maintain the pace of economic activity, if necessary (See remarks about Bernanke's speech above).
The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.
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