The man with the golden gun

Erring towards too much stimulus, for too long, is plainly preferable to Ben Bernanke than a repeat of the years following the Great Depression. And financial markets are thrilled to hear it.

Hold on to your hat!

It looks like the flood of easy money in the US will be around for a little longer, a point that will no doubt continue to underpin asset prices, economic growth and inflation (Fed bubble dangers in the bargain, September 19).

The US Federal Reserve shocked the market by maintaining its bond purchasing program or amount of quantitative easing at a level of $US85 billion a month. The decision means that the Fed will keep printing money to buy bonds at an annualised rate of around $US1 trillion as it pump primes the world’s biggest economy into a space where it grows, creates jobs and generates a higher rate of inflation.

The vast majority of the market anticipated some scaling back or tapering in the amount of QE as the US economy has improved through the course of 2013. But clearly the Fed and its chairman, Ben Bernanke, have a different assessment and they are keen to keep monetary policy at full throttle until they are sure that the private sector has enough momentum to keep growing. 

Bernanke put it plainly for all: “the economic data does not warrant a taper”. He noted that the current bond purchasing program was tied to the performance of the labour market and that the labour market was still soft. Despite the fall in the unemployment rate in recent years, the participation rate has also crashed to a 30-year low and hours worked remain weak, which suggests there is still a huge amount of spare capacity in the labour market.

Financial markets reacted to the policy shock with gusto (Taper tie-up, September 19). Stocks hit fresh record highs, bond yields fell sharply and the US dollar fell precipitously. Commodity prices also shot higher on the basis of a more favourable outlook for growth and inflation.

The Australian dollar traded above 0.9525 US cents, which seems appropriate given the dynamics of super stimulatory policy in the US. It now seems likely that the Australian dollar will test parity again in the not too distant future.

In terms of the Fed statement and its decision to maintain the level of QE, it “decided to await more evidence that progress will be sustained before adjusting the pace of its purchases”. Critical in this assessment was the sharp rise in bond yields in recent times, which the Fed saw as “a tightening in financial conditions [which] could slow the pace of improvement”.

In other words, the sharp rise in bond yields was in itself threatening to derail the positive growth momentum for the economy as those higher borrowing costs fed into corporate borrowing rates and mortgage interest rates for new loans. The Fed was clearly not willing to watch this happen, unchecked.

In a press conference after the policy announcement, chairman Bernanke hosed down those disappointed in the Fed (in)action noting that “asset purchases are not on a pre-set course”. In other words, the members of the Fed will, like mere mortals, act according to news that is set before it.

In thinking about what the Fed is doing with policy at the moment, it is important to recall that Bernanke’s academic mastery was as a student of the 1930s Great Depression. One critical judgment he and many others make about that sorry episode in US economic history is that the policy makers firstly did not deliver sufficient stimulus quickly enough to arrest the economic slide, and then when there were tentative signs that the stimulus was working, it was withdrawn, prematurely.

This early policy reversal in the 1930s kept the economy is depression for a decade. Clearly, Bernanke does not want a repeat of that and is happy to deliberately err on the side of having too much stimulus for too long. In taking this approach, Bernanke is ensuring that the economic outlook for the US remains favourable.

In terms of the policy outlook, it will be back to the task of data watching to determine when the Fed might start to scale back on QE. It sounds trite to suggest that if the data are strong, QE will be scaled back soon, if it is soft, QE will be maintained for longer. Bernanke simply noted that the first step in tapering QE was ‘possible’ later this year.

In other words, sit back, grab some popcorn and a cold drink and watch the data flow. Only when you see that data will you or the Fed know which way monetary policy is going to go.

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