Photo: Wikimedia Commons
As we wait for Bernanke’s 10:00 AM speech at Jackson hole, let’s take a quick trip back to 2010, when Bernanke introduced the world to QE2.In the speech (which you can download here) Bernanke was talking in a post-crisis environment where growth was still quite mediocre and in need of help.
After addressing the state of things, he said the magic words, which don’t come until the 10th page of the speech:
Notwithstanding the fact that the policy rate is near its zero lower bound, the Federal Reserve retains a number of tools and strategies for providing additional stimulus. I will focus here on three that have been part of recent staff analyses and discussion at FOMC meet- ings: (1) conducting additional purchases of longer-term securities, (2) modifying the Committee’s communication, and (3) reducing the interest paid on excess reserves. I will also comment on a fourth strategy, proposed by several economists—namely, that the FOMC increase its inflation goals.
A first option for providing additional monetary accommodation, if necessary, is to expand the Federal Reserve’s holdings of longer- term securities. As I noted earlier, the evidence suggests that the Fed’s earlier program of purchases was effective in bringing down term premiums and lowering the costs of borrowing in a number of pri- vate credit markets. I regard the program (which was significantly ex- panded in March 2009) as having made an important contribution to the economic stabilisation and recovery that began in the spring of 2009. Likewise, the FOMC’s recent decision to stabilise the Fed- eral Reserve’s securities holdings should promote financial conditions supportive of recovery.
I believe that additional purchases of longer-term securities, should the FOMC choose to undertake them, would be effective in further easing financial conditions. However, the expected benefits of additional stimulus from further expanding the Fed’s balance sheet would have to be weighed against potential risks and costs. One risk of further balance sheet expansion arises from the fact that, lack- ing much experience with this option, we do not have very precise knowledge of the quantitative effect of changes in our holdings on financial conditions. In particular, the impact of securities purchases may depend to some extent on the state of financial markets and the economy; for example, such purchases seem likely to have their largest effects during periods of economic and financial stress, when markets are less liquid and term premiums are unusually high. The possibility that securities purchases would be most effective at times when they are most needed can be viewed as a positive feature of this tool. However, uncertainty about the quantitative effect of securities purchases increases the difficulty of calibrating and communicating policy responses.