26 August 2011

A House Divided: A Synopsis of Bernanke's Speech at Jackson Hole, and What It Means



When listening to a speech like this, one has to remember who is speaking and under what conditions. A Fed Chairman has a thousand watt megaphone attached to his chest, and so he must speak quietly and calmly, in order not to disrupt markets and place the Fed in the middle of political controversies. Unless you have actually been close to or in a position of power, where your words carry great significance, it is all too easy to forget this.

Bernanke addressed his problem with the dysfunctional Congress, gridlocked by luddites and libertines, and the serpentine leadership style of Obama.  He is trying to stand his monetary policy on a two legged stool, and it is not working.  The all important fiscal side of economic governance is broken.  Not so much that it is doing the wrong things.  Rather, the process itself is broken, hopelessly frozen by ideological warfare and implacable extremes.

He reiterated that the Fed has the additional policy tools to deal with the situation, in addition to the unprecedented actions they have taken already, although there is a lack of consensus on his own Fed. It is significant that they have expanded their September meeting from one to two days in order to discuss this more fully.

Bernanke gave a particularly sharp rebuke to the Congress, at least by Fed Chairman standards, for the debt ceiling deadlock and discussions that recently shook confidence in the markets.

There is little doubt in my mind that the Fed will put some additional scalable programs in place before the end of the year. The introduction of new programs during a Presidential election year is typically considered to be only acceptable at extreme risks to the banking system and obvious duress to the economy.

As a reminder, there will be another Non-Farm Payrolls number out next week.

There are forces in the US that are on the offensive, and pushing for a crisis in order to better obtain their objectives. What Bernanke is doing is positioning the Fed on the sidelines as best he can, while signaling that they will act once again, overtly or quietly, to prevent a major financial breakdown.

But he is stressing that the Fed has done quite a bit already, and they cannot do it alone. The monetary actions are ineffective without a fiscal counterpart. Like most observers, the Fed sees a broken governance process, and the new super-committee is likely destined to fail in more gridlock. The Fed will not act again except under the duress of an approaching crisis, although they will have the programs in place in anticipation of that crisis.

The US is a house divided against itself. Until the system of governance is repaired, the Fed cannot be reasonably expected to take up the burden of the nation's problems on its own.

So for the future, listen to what the Fed says, but more importantly, watch what the Fed does. And some of that may be opaque, at least for the time being.

This is not necessarily what I think, or what I would do if, God forbid, I was the Fed Chairman. This is what Bernanke is thinking in his own words, and what I believe he is doing, and to some extent, why he is doing it.

Fri Aug 26, 2011 10:00am EDT

JACKSON HOLE, Wyoming, Aug 26 (Reuters) - The following are highlights of Federal Reserve Chairman Ben Bernanke's speech on Friday to a central bank conference sponsored by the Kansas City Federal Reserve Bank.

On economic growth, inflation outlook:

"The recent data have indicated that economic growth during the first half of this year was considerably slower than the Federal Open Market Committee had been expecting, and that temporary factors can account for only a portion of the economic weakness that we have observed.   Consequently, although we expect a moderate recovery to continue and indeed to strengthen over time, the Committee has marked down its outlook for the likely pace of growth over coming quarters.

"With commodity prices and other import prices moderating and with longer-term inflation expectations remaining stable, we expect inflation to settle, over coming quarters, at levels at or below the rate of 2 percent, or a bit less, that most Committee participants view as being consistent with our dual mandate."

On what the Fed's recent policy decision means:

"We indicated that economic conditions -- including low rates of resource utilization and a subdued outlook for inflation over the medium run -- are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013. That is, in what the Committee judges to be the most likely scenarios for resource utilization and inflation in the medium term, the target for the federal funds rate would be held at its current low levels for at least two more years."

On what other tools the Fed has:

"In addition to refining our forward guidance, the Federal Reserve has a range of tools that could be used to provide additional monetary stimulus. We discussed the relative merits and costs of such tools at our August meeting. We will continue to consider those and other pertinent issues, including of course economic and financial developments, at our meeting in September, which has been scheduled for two days (the 20th and the 21st) instead of one to allow a fuller discussion. The Committee will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools as appropriate to promote a stronger economic recovery in a context of price stability."

On market volatility:

"Financial stress has been and continues to be a significant drag on the recovery, both here and abroad. Bouts of sharp volatility and risk aversion in markets have recently reemerged in reaction to concerns about both European sovereign debts and developments related to the U.S. fiscal situation, including the recent downgrade of the U.S. long-term credit rating by one of the major rating agencies and the controversy concerning the raising of the U.S. federal debt ceiling. It is difficult to judge by how much these developments have affected economic activity thus far, but there seems little doubt that they have hurt household and business confidence and that they pose ongoing risks to growth. The Federal Reserve continues to monitor developments in financial markets and institutions closely and is in frequent contact with policymakers in Europe and elsewhere."

On long-term economic growth prospects:

"It may take some time, but we can reasonably expect to see a return to growth rates and employment levels consistent with those underlying fundamentals ... Notwithstanding the severe difficulties we currently face, I do not expect the long-run growth potential of the U.S. economy to be materially affected by the crisis and the recession if -- and I stress if -- our country takes the necessary steps to secure that outcome."

On the impact of monetary and fiscal policy:

"Normally, monetary or fiscal policies aimed primarily at promoting a faster pace of economic recovery in the near term would not be expected to significantly affect the longer-term performance of the economy. However, current circumstances may be an exception to that standard view ... The quality of economic policymaking in the United States will heavily influence the nation's longer-term prospects. To allow the economy to grow at its full potential, policymakers must work to promote macroeconomic and financial stability; adopt effective tax, trade, and regulatory policies; foster the development of a skilled workforce; encourage productive investment, both private and public; and provide appropriate support for research and development and for the adoption of new technologies."