An assessment of a 7-year old speech. Part 1

Like Ma$e in 1999 we Double Up!
This post is divided in two parts.

”The U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.”

These are the words of Ben Bernanke from a speech he gave before the National Economists Club, Washington, D.C. November 21, 2002, long before he was elected Chairman of the Federal Reserve. What he did not know back then was that only six years later he would find himself and the world thrown into the worst economic crisis since WWII and that he would indeed keep the presses running. Recently the Fed decided to continue its QE-program and to expand it. That means another $ 1.4 trillion from the presses!

What is interesting is that Bernanke in his speech presented a theoretical base for how the Fed would be able to stimulate the economy with interest rates at zero and that today interest rates in the U.S. and many other countries are precisely zero or near zero.

To see the relevance of this today and to see why it can be interesting to look closer at what Bernanke said in his speech let us take a closer look at what deflation and its effects really are. To use Bernanke's own words from 2002:

"Deflation is in almost all cases a side effect of a collapse of aggregate demand--a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers…/…/the economic effects of a deflationary episode, for the most part, are similar to those of any other sharp decline in aggregate spending--namely, recession, rising unemployment, and financial stress."

So, a sharp decline in demand which leads to deflation which then leads to recession, rising unemployment and financial troubles. Sounds familiar anyone?

Surely, the present crisis did not start because of deflation that was caused by a decline in aggregate demand, it happened because of bad loans in the financial sector. These loans have however led to a colapse in worldwide demand and that has in turn led to inflation turning negative in many parts of the world including Sweden, where inflation was -0,7 % in november, in other words; deflation. It has also led to rising unemployment, the worst recession since the WWII and global financial markets in crisis and interest rates close to or at zero. Although these current low interest rates are not a result of deflation but rather conscious decisions by central banks, they have however put many central banks including the Fed in the situation that Bernanke was discussing in his speech 2002, leaving them without their traditional weapon to stimulate the economy.

(This post is continued in the post below)

An assessment of a 7-year old speech. Part 2

(Continued from the post above)

So, let us look at what Bernanke in 2002 said could be done in a situation as the one we have today when interest rates are at zero and then look at what has been done until today during the crisis.
(Worth considering is that deflation during current condtitions is rather something positive, since it cushions the otherwise inflationary measures that goverments and central banks has been taking. That is however a subject for another post.)

• "To stimulate aggregate spending when short-term interest rates have reached zero, the Fed must expand the scale of its asset purchases or, possibly, expand the menu of assets that it buys. Alternatively, the Fed could find other ways of injecting money into the system--for example, by making low-interest-rate loans to banks or cooperating with the fiscal authorities."

Yes. Done. The Fed has expanded its purchases and the type of assests through its QE-program and continue doing so (see the $ 1,4 trillion above). It has cooperated with fiscal authorities in the T.A.R.P-program and banks has been able to borrow from the Fed at essentially no cost.

• "One relatively straightforward extension of current procedures would be to try to stimulate spending by lowering rates further out along the Treasury term structure--that is, rates on government bonds of longer maturities…/…/…One approach, similar to an action taken in the past couple of years by the Bank of Japan, would be for the Fed to commit to holding the overnight rate at zero for some specified period."

Yes. Done. The promises by the Fed and other central banks to keep the interests rates low for a long period of time has been vital to keep the economy going and perhaps the most debated subject today is when they will begin to rise again.

• "A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years). The Fed could enforce these interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields." 
  

Yes. Done. First the Fed announced that it would buy long term debt which brought down interests rates and then began to buy them to keep them down. It does however not seem to have helped. Right now 10-year or longer treasury bonds all have rates above 3 %. Maybe all the billions have not been unlimited enough to calm the markets.
 

• ".../…/…the Fed has the authority to buy foreign government debt, as well as domestic government debt"

No. Has not been done and will probably not happen. Probably because the Fed does not want to intervene in the foreign exchange markets.

So to end this post, Bernanke has done almost everything he talked about seven years ago, something I do not think you can say that about alot of people in the politic or economic realm. What is more interesting is seeing that theories can work in the real world as well. Although it is too early to say anything about the final result, most people seem to agree that the actions taken by the Fed and other central banks has helped avoiding the recession getting alot worse.

Bernanke himself back in 2002 also expressed the uncertainty surrounding the measures he then only discussed.

"I should emphasize that my comments on this topic are necessarily speculative, as the modern Federal Reserve has never faced this situation nor has it pre-committed itself formally to any specific course of action should deflation arise…/…/…One important concern in practice is that calibrating the economic effects of nonstandard means of injecting money may be difficult, given our relative lack of experience with such policies."