In testimony before Congress today, Bernanke explained why the Fed’s large-scale asset purchases are continuing.
Inflation as measured by the CPI or PCE deflator has been about 1% over the last year, while the most recent report put the unemployment rate at 7.5%. Bernanke observed:
With unemployment well above normal levels and inflation subdued, fostering our congressionally mandated objectives of maximum employment and price stability requires a highly accommodative monetary policy. Normally, the Committee would provide policy accommodation by reducing its target for the federal funds rate, thus putting downward pressure on interest rates generally. However, the federal funds rate and other short-term money market rates have been close to zero since late 2008, so the Committee has had to use other policy tools….
Bernanke claimed that the tools the Fed has been using (forward guidance and large-scale asset purchases) have been having desirable effects:
In the current economic environment, monetary policy is providing significant benefits. Low real interest rates have helped support spending on durable goods, such as automobiles, and also contributed significantly to the recovery in housing sales, construction, and prices. Higher prices of houses and other assets, in turn, have increased household wealth and consumer confidence, spurring consumer spending and contributing to gains in production and employment. Importantly, accommodative monetary policy has also helped to offset incipient deflationary pressures and kept inflation from falling even further below the Committee’s 2 percent longer-run objective.
Notwithstanding, the Fed chair noted some drawbacks to low interest rates in that they reduce income for savers and could lay the groundwork for future financial instability. But Bernanke suggested that ultimately the Fed’s policies will benefit these as well:
the FOMC actively seeks economic conditions consistent with sustainably higher interest rates. Unfortunately, withdrawing policy accommodation at this juncture would be highly unlikely to produce such conditions. A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further. Such outcomes tend to be associated with extended periods of lower, not higher, interest rates, as well as poor returns on other assets. Moreover, renewed economic weakness would pose its own risks to financial stability.
Bernanke also emphasized that the Fed is prepared to increase or decrease its level of large-scale asset purchases when conditions change:
At its most recent meeting, the Committee made clear that it is prepared to increase or reduce the pace of its asset purchases to ensure that the stance of monetary policy remains appropriate as the outlook for the labor market or inflation changes.
In the question-and-answer session, Bernanke further emphasized that the Fed is not announcing some calendar schedule for ending or tapering LSAP:
I want to be very clear that a step to reduce the flow of purchases would not be an automatic, mechanistic process of ending the program. Rather, any change in the flow of purchases would depend on the incoming data and our assessment of how the labor market and inflation are evolving.
When asked specifically if purchases would be lowered before Labor Day (September 2), Bernanke answered “I don’t know.”
So I guess I don’t either.