The biggest speech of the week is coming up: Bernanke’s 10:00 AM ET speech at the Jackson Hole Economic Symposium sponsored by the Kansas City Federal Reserve.
It was at this venue in 2010, when he introduced the world to QE2, a scheme whereby the Fed would purchase long dated bonds with the idea of pushing money out of the Treasury market and into more risky assets, and hopefully the real economy itself.
With the economy growing (but underwhelmingly so), and Europe and China both flagging, there’s a lot of hope and hype about what he might say, and do.
There are very few clues. One is that the title is going to be: Monetary Policy Since the Crisis.
From that title alone, Goldman’s Jan Hatzius came up with 6 possible lessons that Bernanke might reveal:
- Financial crises and housing downturns have large negative effects on aggregate demand.
- Some well-worn rules of thumb of macroeconomics don’t apply when the economy is stuck at the zero bound.
- The zero lower bound on nominal interest rates is a more serious obstacle to making monetary policy sufficiently accommodative than many economists–including Ben Bernanke–had thought prior to 2007.
- Unconventional Fed balance sheet policies work mainly through the asset side (i.e. the so-called portfolio balance effects) rather than through the liability side (i.e. the amount of bank reserves in the system).
- Sustained periods of high unemployment can result in “hysteresis”
- Inflation expectations are even more “anchored” than economists thought before the crisis.
But beyond the lessons about policy, what investors/traders care about is what he says that’s forward looking.
And here we have a range of options.
He might just use the speech to say that QE is only modestly effective, and that it’s really up to Congress to fix both the fiscal cliff and the long-term debt situation. If he says this, it will be interpreted as pretty hawkish and bum anyone out for more easing.
Or he might reiterate the power of tools like QE. He probably won’t give an ironclad commitment to do more monetary easing, but if he spends time explaining how the Fed has a lot of ammo left, including QE3, and that there’s evidence that it’s useful, and that if conditions don’t get better soon he’ll use it, that would be a little more dovish.
Beyond that, things start to get really interesting.
Vincent Reinhart of Morgan Stanley thinks the “surprise” of the day would be if Bernanke went into more depth on “conditional” strategies or what might be called “unconventional unconventional” measures.
Basically, these would be commitments “Do X until X is achieved.”
The main possibility for surprise is if he addresses the ongoing work within the Fed on conditional policy rules. The last set of minutes referred several times to discussions of rules and more open-end policy commitments. Up to now, the Fed has been using its policy instruments in an unconditional way, in that it announces a program of fixed duration and fixed amount. Most academic work, as will be discussed in the formal program at Jackson Hole, suggests that a rule linking the policy instrument to economic outcomes or the outlook performs better.
The idea is that the Fed could agree, for instance, to keep the funds rate target at zero as long as they have an economic forecast that is short of their mission. The problem is that the mission at the heart of Fed policy-making is ambiguous. In the Federal Reserve Act, the Congress tells the Fed to foster maximum employment and stable prices but is silent on how to weigh deviations from the two objectives or how quickly those deviations should be eliminated. The monetary policymakers at the Fed are a diverse group of people who disagree on how to fill this silence. If they can come to terms with this issue, then they can offer more open-ended assurance to financial market participants and the public at large. Chairman Bernanke is unlikely to offer a Solomonic solution, but his speech would be more interesting if he relayed where they are in the process.
Depending on how far along this road he goes, this is where things start to get interesting.
If he says anything about, say, Nominal GDP targeting (Fed policy that commits to the economy hitting some combination of inflation + growth), he could send shock waves through markets. Even just suggesting that it’s entering the conversation (which it definitely is in academic circles, but not necessarily within the Fed itself) would be huge news.
The odds are likely long, but there’s definitely an avenue for it to be very interesting.
We’ll be covering the speech LIVE at 10:00 AM ET.