Bernanke: QE3 possible, cost-benefit approach to be taken

Geoffrey Malloy Contributor
Font Size:

Federal Reserve Chairman Ben Bernanke left the door open to a third round of quantitative easing in his annual Jackson Hole, Wyo., speech Friday.

While not committing to additional purchases of securities, Bernanke noted, “the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.”

Quantitative easing, known as “QE,” involves the Federal Reserve purchasing long-term assets, such as private debt and government securities, from financial institutions in order to increase the supply of money in the economy.

During recessions, QE is undertaken in order to prevent deflation, which can cause people to save rather than spend.

The Federal Reserve has undertaken two rounds of QE since the 2008 financial crisis. Some economists, such as Paul Krugman, have advocated a third round of QE.

During the first two rounds of quantitative easing, the Fed extended loans to Citigroup and AIG and purchased mortgage-backed securities from Fannie Mae and Freddie Mac.

The Fed also loaned $553 billion to a number of foreign central banks as part of a currency swap program.

Discussing such programs, Bernanke said, “Extensive analyses suggest that, from a purely fiscal perspective, the odds are strong that the Fed’s asset purchases will make money for the taxpayers, reducing the federal deficit and debt.”

Throughout much of the speech Bernanke defended the use of nontraditional monetary policy in response to the 2008 financial crisis.

“It seems clear, based on this experience, that such policies can be effective, and that, in their absence, the 2007-09 recession would have been deeper and the current recovery would have been slower than has actually occurred,” he explained.

Bernanke recognized, nonetheless, that a number of costs would have to be considered before undertaking further quantitative easing.

He warned that the Fed’s purchase of Treasury bonds could ultimately lead to higher borrowing costs for the U.S. government.

“Market disruptions could lead to higher liquidity premiums on Treasury securities, which would run counter to the policy goal of reducing Treasury yields,” he stated.

“A second potential cost of additional securities purchases is that substantial further expansions of the balance sheet could reduce public confidence in the Fed’s ability to exit smoothly from its accommodative policies at the appropriate time,” Bernanke contended.

“Even if unjustified, such a reduction in confidence might increase the risk of a costly unanchoring of inflation expectations, leading in turn to financial and economic instability.”

Bernanke said the consumer price index remains around two percent, the Fed’s ultimate target for the inflation measure.

Bernanke also noted that excessively low interest rates could encourage banks to undertake excessive leverage and risk. He contended, however, that the Fed had not noticed such a trend in bank portfolios.

Bernanke reiterated the Federal Reserve’s commitment to keeping short-term interest rates near zero at least through 2014.

The economic recovery is weaker than what the Fed chairman had hoped for, given the expansionary monetary and fiscal policy employed by the federal government in wake of the financial crisis.

“In light of the policy actions the FOMC [Federal Open Market Committee] has taken to date, as well as the economy’s natural recovery mechanisms, we might have hoped for greater progress by now in returning to maximum employment,” he said.

The nation’s chief central banker weighed in on the fiscal issues facing the federal government, making clear that “it is critical that fiscal policymakers put in place a credible plan that sets the federal budget on a sustainable trajectory in the medium and longer runs.”

Bernanke explained that the central bank’s actions following the financial crisis were informed by “limited historical experience.” Central bankers, he said, “have been in the process of learning by doing.”

Follow Geoffrey on Twitter