Bernanke's Jackson Hole Message August 31, 2010, Bob Eisenbeis, Chief Monetary Economist
Markets eagerly awaited Chairman Bernanke's remarks at the Federal Reserve Bank of Kansas City's annual Jackson Hole conference last week, in hopes that he might provide more clarity on Fed policy. However, the media struggled to find anything newsworthy in the speech. The best the Wall Street Journal could do, for example, was to note that the Chairman seemed to open the door to "bolder" policy moves, should the downside risks to its forecast actually be realized. But this isn't news and is exactly the kind of conditional statement the FOMC has been including for more than a year in its release following each meeting. In his speech, the Chairman also described four possible tools that the FOMC had at its disposal to further ease policy, including (1) purchasing additional long-term securities, (2) changing its communications strategy, (3) reducing the rate paid on excess reserves, and (4) as suggested by some outside economists, increasing its inflation goals. He went on to discuss the limitations of each of these strategies and rejected out of hand changing the FOMC's inflation objectives.
What seems to have been lost in the parsing of the speech is the Chairman's attempt to be totally forthright in his discussion of the limitations of these policy options and, by implication, what this might mean for the FOMC's likely exit strategy or its response to the realization of unusual downside risks to the economy. In each case, he cited limitations, costs, or weaknesses associated with these options. For example, in discussing additional asset purchases, he noted both that (a) "(o)ne risk of further balance sheet expansion arises from the fact that, lacking much experience with this option, we do not have very precise knowledge of the quantitative effect of changes in our holdings on financial conditions" and (b) the risk that additional expansion might reduce the public's confidence in the " ... Fed's ability to execute a smooth exit from its accommodative policies at the appropriate time." In discussing modifying communications options, he pointed to the difficulties and mixed results that other central banks have had, and candidly expressed the concern he has in how to communicate clearly the degree of conditionality such guidance may entail.
The whole discussion in the media of the speech and the Fed's policy dilemma brings to mind an analogy between the monetary policy formulation process currently facing the Fed and a recent discussion at my golf club by a USGA agronomist of the problems faced this year by Atlanta greenskeepers in dealing with the weather's devastating effects on our greens. During normal times, their focus is on playability, which primarily involves fine-tuning the speed of the greens through the selective use of water, fertilizer, pesticides, and aeration. This is exactly what the FOMC attempts to do in normal times by adjusting the funds rate target, discount rate, and rate paid on excess reserves to achieve a balance between inflation and growth. However, these aren't normal times, and like the greenskeepers who are now only focused on survivability of the greens, the Fed's focus is simply upon triage for the financial system and getting the economy growing again. The Fed has already exhausted its allotment of interest-rate "fertilizer," and anyone with a lawn knows that when grass is dying, more fertilizer may simply accelerate the process. Other tools may be available, like water and air movement, but in a crisis it is hit or miss in terms of how much to use, what the proper mix is, or what their effects will be. This is precisely what the Chairman has said and reflects the policy problem facing the FOMC. The economy is struggling, interest rates can't really be lowered further, and how much or at what pace more quantitative easing or other policies may be appropriate is simply unknown. Under these circumstances, any greenskeeper knows that while a little bit of fertilizer may be a good thing, more is not necessarily better or appropriate; but markets and many commentators appear to be naively assuming that more is better.
What Bernanke attempted to do is to indicate that while the tools are available, there are risks associated with their use. The implication for investors and markets should be that the FOMC will be cautious in taking actions and will likely do so in a deliberate and measured way. This means that rates will continue to be low, perhaps through the end of 2011 and even well into 2012; and any policy actions, either to reverse course or to respond to unwanted realization of downside risks will be incremental rather than dramatic.
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