Investors around the world are waiting to find out whether Federal Reserve Chairman Ben Bernanke puts any QE3 in his opening remarks today at the Kansas City Fed’s Jackson Hole conference. It was one year ago at the same event that he outlined the Fed’s policy options for an ailing economy, including a second round of quantitative easing that started in early November.
A second audience will be listening to Bernanke -- not as closely, perhaps, nor in real time, but with no less a stake in the outcome: retirees living on fixed incomes who have watched their returns dwindle to almost nothing.
Bernanke has already told this group to forget about earning a higher rate of interest anytime soon. At the conclusion of its Aug. 9 meeting, the Fed announced it would keep the benchmark rate near zero “at least through mid-2013.” What’s a small saver to do?
Monetary policy isn’t offering much solace in the short run. That’s because the Fed adjusts interest rates and, in so doing, changes the incentives to spend and to save.
When inflation-adjusted interest rates are high, the public is induced to forego current consumption in favor of future consumption. In plain talk, we’re being paid to save.
Alternatively, when real rates are low or negative, as they are now, the incentive is to spend today and forget about saving for a rainy day. Interest rates act as a guide to our choices.
That’s one explanation of how monetary policy works. There are others. While currently out of favor, monetarism teaches that if the Fed creates more money than the public wants to hold, people will spend it. It’s akin to dropping money from a helicopter, the metaphor adopted by the late Milton Friedman to teach his University of Chicago students how monetary policy works.
Bernanke explains it in a different way. Once short-term rates hit zero, monetary policy works through the portfolio balance channel, a theory he outlined at Jackson Hole last year. Specifically, when the Fed buys risk-free Treasuries, it depresses the yields and forces investors to buy other assets that carry increased credit and interest-rate risk -- long-term corporate bonds or stocks, for example.
In a Nov. 19 speech, he even argued that there was no Q in quantitative easing. The thrust of QE, he said, comes from changing the quantity of bank reserves, a channel he called weak. Securities purchases, on the other hand, work through portfolio substitution.
“The Fed should talk in terms of reserves, not asset prices,” said Marvin Goodfriend, a professor of economics at Carnegie Mellon University in Pittsburgh and a former research director at the Richmond Fed.
The reason? To remind the public of the Fed’s unique authority, independent of the political process, “to stabilize the purchasing power of money,” Goodfriend said.
Maybe it’s just a case of bad marketing, although the Fed has been emphasizing the asset side of its balance sheet since December 2008, when it lowered the funds rate to near zero. For an institution that is so concerned with its communication policy, the Fed could do better. The talk about forcing investors to assume more risk sounds as if the Fed is encouraging Gram and Gramps to redeem those six-month Treasury bills, cash out of the money-market fund and let the CDs mature, and go out and buy stocks and high-yield bonds.
Small savers and retirees have reason to be upset. It’s as if monetary policy has been personalized to punish one group that behaved well (savers) and reward another that over-borrowed and over-spent.
Daily 400-point swings in the Dow Jones Industrial Average aren’t for everyone. Most octogenarians, I’d venture to say, prefer less volatility.
Goodfriend says the Great Inflation of the 1970s soured many savers on owning long-term bonds. They opted for short-term instruments instead, which left them vulnerable to periodic bouts of ultra-low rates (the periods seem to be getting longer).
Besides, the Fed’s extended policy of zero-percent interest rates is apt to spark a bubble in some unexpected asset class. (Farm land and student loans have been mentioned as possible candidates.) When it comes to bubble identification, the Fed is the last one to know and even slower to admit to a role in its creation.
The Fed tries to be neutral in its conduct of monetary policy, buying Treasuries only and no other asset classes. (The various lending facilities created in 2007 and 2008 to deal with the financial crisis are the exception.) In the same spirit, the central bank needs to communicate that it’s running monetary policy for everyone, not just sophisticated investors.
Don’t Forget Gramps
“A policy that is effective in getting the economy to grow more rapidly will improve the lives of most people,” says former St. Louis Fed President Bill Poole.
Stronger growth means more hiring, more income, bigger profits, higher stock prices and higher real interest rates.
Figuring out what’s “effective” isn’t so easy. I doubt that Bernanke will offer any new solutions today. After all, three members of the Fed’s policy committee dissented from the Aug. 9 decision to commit to near-zero rates through mid-2013.
Inflation readings are much higher than they were a year ago: 3.6 percent versus 1.2 percent for the consumer price index; 1.8 percent versus 0.9 percent for the core CPI, which excludes food and energy and is given more weight by policy makers. The bar for additional Fed action has been raised.
Whatever Bernanke says or doesn’t say is sure to have a market impact. Stocks, for example, will probably be disappointed without the prospect of a Fed fix.
As for Gram and Gramps, who won’t be attending this or any Fed symposium, Bernanke will have nothing to offer. At minimum he could acknowledge their predicament and stop encouraging them to buy junk bonds.
(Caroline Baum, author of “Just What I Said,” is a Bloomberg View columnist. The opinions expressed are her own.)
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