Tag: Federal Reserve Bank

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Will the Fed redouble its efforts to prevent a double dip?

Recent data on the US economy suggest that it may be heading back towards recession. Confidence is waning as growth slows. US GDP growth figures for the second quarter of 2010 have just been revised downwards: from 2.4% to 1.6%. And although growth is still quite strongly positive, unemployment is not coming down.

Most economists still think that the US economy will avoid a double dip, but many think that it is nevertheless a distinct possibility. For example, economists at Goldman Sachs put the likelihood of a double-dip recession at 25% to 30%, which although less than 50% is still a substantial risk.

Ben Bernanke, Chairman of the Federal Reserve, told a gathering of bankers and economists in Wyoming on August 27 that the Fed “will do all that it can” to avoid a double dip. According to Bernanke:

In many countries, including the United States and most other advanced industrial nations, growth during the past year has been too slow and joblessness remains too high… Central bankers alone cannot solve the world’s economic problems. That said, monetary policy continues to play a prominent role in promoting the economic recovery and will be the focus of my remarks today.

Bernanke outlined four monetary policy options that could be pursued, the first three of which were real possibilities for the Fed if economic growth did stall.

• The first would be to sell long-term government securities on the open market – a form of open-market operation. This quantitative easing would expand the money supply and should push long-term interest rates down (short-term interest rates are already virtually zero).

• The second would be to reduce interest rates paid to banks on reserves held in the Fed. These are currently around 0.25% and hence the scope for reductions here are very limited

• The third would be to promise to keep short-term interest rates low for a longer period than markets currently expect, thereby assuring markets that borrowing would remain cheap for some considerable time.

• The fourth option, and one not currently contemplated by the Fed, would be to raise the inflation rate target above its current level of 1.5% to 2%.

The first of the following two podcasts, which includes an interview with US Managing Editor of the Financial Times, Gillian Tett, looks at what the Fed might do. Is the solution to expand aggregate demand through monetary policy or are the problems more structural in nature? The other podcasts and the articles look at Bernanke’s proposals and their scope for avoiding a double dip.

Podcasts
‘No magic wand’ for US economy BBC Today Programme, Mark Mardell and Gillian Tett (27/8/10)
Fed Offers Higher Ground In Economic Mudslide NPR, Scott Horsley (28/8/10)
Roubini Interview Excerpt Bloomberg, Nouriel Roubini (27/8/10)

Articles
Bernanke Says Fed Will Do `All It Can’ to Ensure U.S. Recovery Bloomberg, Craig Torres and Scott Lanman (27/8/10)
What ammunition does the Fed have left? Reuters (27/8/10)
Fed is prepared to keep U.S. out of recession, Bernanke vows Los Angeles Times, Jim Puzzanghera (28/8/10)
Bernanke soothes rattled markets Telegraph (28/8/10)
Ben Bernanke promises to step in as US economy veers back towards recession Guardian, Katie Allen (27/8/10)
Shoot out at Jackson Hole – the world’s central bankers take aim at deflation Independent, Sean O’Grady (27/8/10)
Treasury Two-Year Yields Increase Most Since April After Bernanke Speech Bloomberg, Cordell Eddings (28/8/10)
Bernanke speech shows effort to find Fed consensus One News Now, Jeannine Aversa (28/8/10)
Analysis: The uncomfortable mathematics of monetary policy Reuters, Pedro Nicolaci da Costa (28/8/10)
Ben Bernanke calls for help to revive the stuttering US economy Guardian, Richard Adams (28/8/10)
Fed stands by to boost US growth Financial Times, Robin Harding, Michael Mackenzie and Alan Rappeport (27/8/10)
Bernanke outlines options for Fed Financial Times, Robin Harding (27/8/10)

Speech
The Economic Outlook and Monetary Policy Ben Bernanke (27/8/10)

Data
US Bond Rates Yahoo Finance
US interest rates Federal Reserve Statistical Release

Questions

  1. Why is growth in the US economy slowing?
  2. Why has the recovery from recession in the USA so far not resulted in a reduction in unemployment?
  3. What structural problems are there in the US economy?
  4. What further scope is there for monetary policy in stimulating the US economy?
  5. What are the arguments for the Fed introducing a new programme of quantitative easing?
  6. How important are expectations in determining whether the US recovery will be maintained or whether there will be a double-dip recession?
  7. What impact did Bernanke’s speech have on bond markets and why?
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Easy money from the Fed?

The US economic recovery is slowing. As consumer and business confidence wanes, so there is growing talk of a double-dip recession. So what’s to be done about it? How can aggregate demand be boosted without spooking the markets?

One solution would be for a further fiscal stimulus. The one instituted in January 2009 in the depth of the recession has virtually worked itself out, with many short-term projects financed by the stimulus having come to an end. But any further stimulus would cause further worries about America’s balooning public-sector deficit, which already is predicted to be some 10.6% for 2010 (up from 1.1% in 2007).

The alternative is to use monetary policy. But, with the Federal Reserve rate already at between 0% and 0.25% (where it has been since the end of 2008), there is no scope for further cuts in interest rates. If monetary policy is to be used to give an additional boost to the economy, then further quantitiative easing is necessary. This is what the Federal Reserve decided to do on 10 August. As the Independent (see link below) states:

The US Federal Reserve decided last night to extend its $1.55 trillion programme of quantitative easing in an attempt to rejuvenate an economic recovery that the central bank admitted was turning out “more modest” than it expected.

The interest rate-setting Federal Open Market Committee bowed to calls from across the financial markets to extend its support, saying it would pump new money into the markets at a rate equivalent to about $200bn a year, and it left the duration of its efforts open-ended.

So how successful is this policy likely to be? The following articles look at the issues.

Articles
‘Light’ quantitative easing for slow US economic recovery New Statesman (11/8/10)
Fed sets the printing press rolling again to juice recovery Independent, Stephen Foley (11/8/10)
US Federal Reserve reveals plan to buy government debt Herald Scotland, Douglas Hamilton (11/8/10)
Some questions and answers on the Fed`s new policy Money Control (11/8/10)
Fed downgrades recovery outlook Financial Times, James Politi and Michael Mackenzie (10/8/10)
Fed acts as US recovery loses steam ABC News, Peter Ryan (11/8/10)
Top Fed Official, Warns Fed Risks Repeating Past Mistakes Huffington Post, Thomas Hoenig (11/8/10)
Austerity or stimulus? Some economists ha
The Fed must address Main Street’s credit crunch The Economist, Guillermo Calvo (15/8/10)
The Fed has options to lower real interest rates The Economist, Mark Thoma (15/8/10)
Fear of renewed recession in America is overblown; so is some of the optimism in the euro area The Economist (12/8/10)
Analysts’ view: Economists divided on effectiveness of Fed move Reuters (11/8/10)
If the Fed’s going to monetise debt, now’s the time to do it The Economist, Laurence Kotlikoff (13/8/10)
A former Fed official offers advice to Ben Bernanke The Economist, Joseph Gagnon (17/8/10)
America’s century is over, but it will fight on Guardian, Larry Elliott (23/8/10)

Federal Reserve documents
Press Release on monetary policy Federal Reserve (10/8/10)
Information on Federal Open Market Committee Federal Reserve

Questions

  1. What are are the arguments for using quantitative easing?
  2. Explain the process by which quantitative easing increases (a) narrow money and (b) broad money.
  3. How has the US and global economic situation changed since June 2010?
  4. Could the Fed’s policy be described as one of quantitative easing or merely one of maintaining the existing quantity of money? Explain.
  5. What are dangers in pursuing a policy of quantitative easing?
  6. What are the arguments for pursuing tight fiscal policy at the same time as loose monetary policy?
  7. Why does Thomas Hoenig claim that the Fed risks repeating past mistakes?
  8. How could the real rate of interest be reduced if the nominal rate is virtually zero and cannot be negative?
  9. Explain what is meant by ‘seigniorage’ (see the final The Economist article above).
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In Fed we trust

This podcast is from MSN’s Slate magazine. It is an interview with David Wessel, author of the book In Fed We Trust: Ben Bernanke’s War on the Great Panic. The book and the podcast consider the recent history of the Federal Reserve Bank of America (the USA’s central bank) and its handling of the sub-prime crisis and the credit crunch.

In Fed We Trust: A podcast with author David Wessel MSN Slate (10/8/09)

Questions

  1. What actions were taken by the Fed as the credit crisis unfolded?
  2. According to David Wessel, what mistakes were made by the Fed in handling the credit crisis?
  3. How successful was the Fed in steering the economy through the credit crisis and subsequent recession?
  4. How is the role of the Fed likely to change in the future?