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THE markets' initial reading of US Federal Reserve chairperson Ben Bernanke's speech at the key Jackson Hole conference of central bankers was that he would do anything in his power to stop a double-dip recession from occurring.
What can he do? Will it be too little, too late? Or will it be inflationary?
The annual meeting of international central bankers at Jackson Hole in the US has become more important since the US fell into recession in December 2007. It has pulled out of the slump, but recent figures have led to fears of a return. Although these fears aren't widespread yet, there is undoubtedly major worry about the US economy – and hence that of the world.
That worry was underscored when the latest US gross domestic product (GDP) revision was released last week. The figures were for the second quarter, initially estimated to have grown at 2.4%.
The revisions have taken that growth rate down to 1.6%, largely reflecting the leakage to GDP from imports. The figure was sharply down from first quarter's 3.7% growth rate.
It's even worse if one bears in mind the 1.6% figure is annualised growth for the quarter from the previous quarter – that means the quarterly growth rate projected forward as if it has taken place over a year. The figure followed other numbers, particularly on the housing market, that showed weakness in the US economy.
"Overall, the incoming data suggest that the recovery of output and employment in the US has slowed in recent months, to a pace somewhat weaker than most FOMC (Federal Open Market Committee) participants projected earlier this year.
'Unconventional' measures
"Much of the unexpected slowing is attributable to the household sector.... I expect the economy to continue to expand in the second half of this year, albeit at a relatively modest pace," Bernanke said in his speech.
Bernanke signalled he didn't expect a double-dip or deflation – that is, falling prices, which would plunge the US economy into gloom.
But, crucially, he said: "Falling into deflation is not a significant risk for the US 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."
With this comment, Bernanke made it clear that the public, the markets and indeed the world expects the Fed to do something if there are signs that things will get worse.
He said: "We will continue to monitor economic developments closely and to evaluate whether additional monetary easing would be beneficial. In particular, the committee is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly."
What can the Fed do? On interest rates, nothing further expect promise to hold them at 0% to 0.25% for a long time. But this is already being done.
The other measures – "unconventional", as Bernanke called them – would comprise buying government bonds, as well as reducing the interest the Fed pays banks on their reserves.
The reason why the Fed buys government bonds in times of crisis is to pump liquidity into the banking system. It then hopes that the banks, flush with cash, will lend the money to consumers.
The Fed bought bonds, and even mortgage bonds, aggressively during the crisis, expanding its balance sheet to $2.3 trillion from $900bn before the crisis.
Then, as it seemed the economy was recovering, it halted bond purchases and allowed its balance sheet to shrink slightly as mortgage bonds matured and it didn't reinvest the proceeds in the market.
Banks cash flush but loan shy
A few weeks ago, the Fed decided to again reinvest these proceeds, thus keeping its balance sheet stable. But it could decide, if it believes things are bad enough, to expand its balance sheet again with more aggressive purchases of government bonds.
Trouble is, it's difficult to envisage such action working wonders. The banks, scared by what happend when they lent to subprime customers, aren't lending money despite being flush with cash.
It's very difficult even for relatively creditworthy customers to get loans in the US these days. Banks are simply hoarding their cash. That's why it would help if the Fed decided to pay less interest on the reserves banks hold at the Fed. (However, at 0.25% this interest is already very low).
But it's not just the banks that are to blame. The US consumer has been scalded by the crisis, and is reluctant to borrow. US consumers are highly indebted, and they are using extra cash to pay down their debts rather than spend.
The fear is that the US is in a "liquidity trap" – the term famous economist John Maynard Keynes coined during the Depression for an economy in which monetary policy easing has become powerless to change anything.
The Keynesian solution is government spending, but there's little political appetite for more of that in Washington.
The Fed is likely to take extra measures if Friday's unemployment data are a disappointment. If it does, it's unlikely to lead to inflation down the line in a country where economic growth is well below potential.
But it might also prove to be a relatively futile exercise.
- Fin24.com
What can he do? Will it be too little, too late? Or will it be inflationary?
The annual meeting of international central bankers at Jackson Hole in the US has become more important since the US fell into recession in December 2007. It has pulled out of the slump, but recent figures have led to fears of a return. Although these fears aren't widespread yet, there is undoubtedly major worry about the US economy – and hence that of the world.
That worry was underscored when the latest US gross domestic product (GDP) revision was released last week. The figures were for the second quarter, initially estimated to have grown at 2.4%.
The revisions have taken that growth rate down to 1.6%, largely reflecting the leakage to GDP from imports. The figure was sharply down from first quarter's 3.7% growth rate.
It's even worse if one bears in mind the 1.6% figure is annualised growth for the quarter from the previous quarter – that means the quarterly growth rate projected forward as if it has taken place over a year. The figure followed other numbers, particularly on the housing market, that showed weakness in the US economy.
"Overall, the incoming data suggest that the recovery of output and employment in the US has slowed in recent months, to a pace somewhat weaker than most FOMC (Federal Open Market Committee) participants projected earlier this year.
'Unconventional' measures
"Much of the unexpected slowing is attributable to the household sector.... I expect the economy to continue to expand in the second half of this year, albeit at a relatively modest pace," Bernanke said in his speech.
Bernanke signalled he didn't expect a double-dip or deflation – that is, falling prices, which would plunge the US economy into gloom.
But, crucially, he said: "Falling into deflation is not a significant risk for the US 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."
With this comment, Bernanke made it clear that the public, the markets and indeed the world expects the Fed to do something if there are signs that things will get worse.
He said: "We will continue to monitor economic developments closely and to evaluate whether additional monetary easing would be beneficial. In particular, the committee is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly."
What can the Fed do? On interest rates, nothing further expect promise to hold them at 0% to 0.25% for a long time. But this is already being done.
The other measures – "unconventional", as Bernanke called them – would comprise buying government bonds, as well as reducing the interest the Fed pays banks on their reserves.
The reason why the Fed buys government bonds in times of crisis is to pump liquidity into the banking system. It then hopes that the banks, flush with cash, will lend the money to consumers.
The Fed bought bonds, and even mortgage bonds, aggressively during the crisis, expanding its balance sheet to $2.3 trillion from $900bn before the crisis.
Then, as it seemed the economy was recovering, it halted bond purchases and allowed its balance sheet to shrink slightly as mortgage bonds matured and it didn't reinvest the proceeds in the market.
Banks cash flush but loan shy
A few weeks ago, the Fed decided to again reinvest these proceeds, thus keeping its balance sheet stable. But it could decide, if it believes things are bad enough, to expand its balance sheet again with more aggressive purchases of government bonds.
Trouble is, it's difficult to envisage such action working wonders. The banks, scared by what happend when they lent to subprime customers, aren't lending money despite being flush with cash.
It's very difficult even for relatively creditworthy customers to get loans in the US these days. Banks are simply hoarding their cash. That's why it would help if the Fed decided to pay less interest on the reserves banks hold at the Fed. (However, at 0.25% this interest is already very low).
But it's not just the banks that are to blame. The US consumer has been scalded by the crisis, and is reluctant to borrow. US consumers are highly indebted, and they are using extra cash to pay down their debts rather than spend.
The fear is that the US is in a "liquidity trap" – the term famous economist John Maynard Keynes coined during the Depression for an economy in which monetary policy easing has become powerless to change anything.
The Keynesian solution is government spending, but there's little political appetite for more of that in Washington.
The Fed is likely to take extra measures if Friday's unemployment data are a disappointment. If it does, it's unlikely to lead to inflation down the line in a country where economic growth is well below potential.
But it might also prove to be a relatively futile exercise.
- Fin24.com
